On Rational Bubbles and Fat Tails
AbstractThis paper addresses the statistical properties of time series driven by rational bubbles a la Blanchard and Watson (1982). Using insights on the behavior of multiplicative stochastic processes, we demonstrate that the tails of the unconditional distribution emerging from such bubble processes follow power-laws (exhibit hyperbolic decline). More precisely, we find that rational bubbles predict a "fat" power tail for both the bubble component and price differences with an exponent mu smaller than 1. The distribution of returns is dominated by the same power-law over an extended range of large returns. Although power-law tails are a pervasive feature of empirical data, these numerical predictions are in disagreement with the usual empirical estimates. It therefore appears that exogenous rational bubbles are hardly reconcilable with some of the stylized facts of financial data at a very elementary level.
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Bibliographic InfoArticle provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.
Volume (Year): 34 (2002)
Issue (Month): 3 (August)
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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879
Other versions of this item:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
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