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Asset Price Volatility, Bubbles, and Process Switching

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  • Robert P. Flood
  • Robert J. Hodrick

Abstract

Evidence of excess volatilities of asset prices compared with those of market fundamentals is often attributed to speculative bubbles. This study examines the sense in which speculative bubbles could in theory lead to excess volatility, hut it demonstrates that some of the variance hounds evidence reported to date precludes bubbles as a reason why asset prices might violate such hounds. The findings must represent some other model misspecffication or market inefficiency. One important misspecification occurs when there searcher incorrectly specifies the time series properties of market fundamentals. A bubble-free example economy characterized by a potential switch in government policies produces paths of asset prices that would appear, to an unwary researcher, to contain bubbles.

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File URL: http://www.nber.org/papers/w1867.pdf
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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1867.

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Date of creation: Feb 1987
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Handle: RePEc:nbr:nberwo:1867

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