A Three-Regime Model of Speculative Behaviour: Modelling the Evolution of Bubbles in the S&P 500 Composite Index
AbstractIn this paper we examine whether a three-regime model that allows for dormant, explosive and collapsing speculative behaviour can explain the dynamics of the S&P 500 Composite Index for the period 1888-2001. We extend existing two-regime models of speculative behaviour by including a third regime that allows for a bubble to grow at a steady growth rate, and examine whether other variables, beyond the deviation of actual prices from fundamental values can help predict the level and the generating state of returns. We propose abnormal volume as an indicator of the probable time of the bubble collapse and thus include abnormal volume in the state and the classifying equations of the surviving regime in the explosive state. We show that abnormal volume is a significant predictor and classifier of returns. Furthermore, we find that the spread of the 6-month average actual returns above the 6-month average fundamental returns can help predict when a bubble will enter the explosive state. Finally, we examine the financial usefulness of the three-regime model by studying the risk-adjusted profits of a trading rule formed using inferences from it. Use of the three-regime model trading rule leads to higher risk adjusted returns and end of period wealth than those obtained from employing existing models or a buy and hold strategy.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Henley Business School, Reading University in its series ICMA Centre Discussion Papers in Finance with number icma-dp2002-14.
Length: 48 pages
Date of creation: Apr 2002
Date of revision:
Publication status: Published in Economic Journal 115:505, 2005, 767-797
Contact details of provider:
Postal: PO Box 218, Whiteknights, Reading, Berks, RG6 6AA
Phone: +44 (0) 118 378 8226
Fax: +44 (0) 118 975 0236
Web page: http://www.henley.reading.ac.uk/
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
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- van Norden Simon & Vigfusson Robert, 1998. "Avoiding the Pitfalls: Can Regime-Switching Tests Reliably Detect Bubbles?," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 3(1), pages 1-24, April.
- Simon van Norden & Huntley Schaller & ), 1995.
"Speculative Behaviour, Regime-Switching, and Stock Market Crashes,"
- Van Norden, S. & Schaller, H., 1996. "Speculative Behaviour, Regime-Switching and Stock Market Crashes," Working Papers 96-13, Bank of Canada.
- Kenneth D. West, 1986.
"A Specification Test for Speculative Bubbles,"
NBER Working Papers
2067, National Bureau of Economic Research, Inc.
- West, Kenneth D, 1988.
" Bubbles, Fads and Stock Price Volatility Tests: A Partial Evaluation,"
Journal of Finance,
American Finance Association, vol. 43(3), pages 639-56, July.
- Kenneth D. West, 1988. "Bubbles, Fads, and Stock Price Volatility Tests: A Partial Evaluation," NBER Working Papers 2574, National Bureau of Economic Research, Inc.
- Blanchard, Olivier Jean, 1979. "Speculative bubbles, crashes and rational expectations," Economics Letters, Elsevier, vol. 3(4), pages 387-389.
- Anderson, Keith & Brooks, Chris & Katsaris, Apostolos, 2010.
"Speculative bubbles in the S&P 500: Was the tech bubble confined to the tech sector?,"
Journal of Empirical Finance,
Elsevier, vol. 17(3), pages 345-361, June.
- Chris Brooks & Apostolos Katsaris, 2006. "Speculative Bubbles in the S&P 500: Was the Tech Bubble Confined to the Tech Sector?," ICMA Centre Discussion Papers in Finance icma-dp2006-07, Henley Business School, Reading University.
- Keith Anderson & Chris Brooks & Sotiris Tsolacos, 2009. "Testing for periodically collapsing rational speculative bubbles in US REITs," ICMA Centre Discussion Papers in Finance icma-dp2009-11, Henley Business School, Reading University.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ed Quick).
If references are entirely missing, you can add them using this form.