Forecasting the Collapse of Speculative Bubbles: An Empirical Investigation of the S&P 500 Composite Index
AbstractIn this paper we test for the presence of periodically partially collapsing, positive and negative, speculative bubbles in the S&P 500 Composite Index for the period 1888-2001. We extend existing regime-switching models of speculative behaviour by including abnormal volume as an indicator of the probable time of the bubble collapse. Abnormal volume is included as both a classifying variable that helps predict the probability of the bubble surviving, and as a factor of risk in the surviving state equation. Increased volume is considered a signal that market beliefs concerning the future of the bubble are changing. We show that abnormal volume is a significant predictor and classifier of returns. Furthermore, we examine the financial usefulness of the augmented model by studying the risk-adjusted profits of a trading rule formed using inferences from it. Use of the augmented model trading rule leads to higher risk adjusted returns than those obtained from employing existing models or a buy and hold strategy.
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Bibliographic InfoPaper provided by Henley Business School, Reading University in its series ICMA Centre Discussion Papers in Finance with number icma-dp2002-04.
Length: 42 pages
Date of creation: Mar 2002
Date of revision:
Publication status: Published in Journal of Business 78:5, 2005, 2003-2036
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More information through EDIRC
Stock market bubbles; fundamental values; dividends; regime switching; speculative bubble tests;
Find related papers by JEL classification:
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
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