This paper tests between fads and bubbles using a new empirical strategy (based on switching regression econometrics) for distinguishing between competing asset pricing models. By extending the Blanchard and Watson (1982) model, we show how stochastic bubbles can lead to regime switching in stock market returns. By incorporating state-dependent heteroscedasticity into the Cutler, Poterba and Summers (1991) fads model, we show that it can also lead to regime switching. Two main features of the bubbles model distinguish it from the fads model. First, the bubbles model implies that returns are drawn from two distinct regimes. Second, the bubbles model implies that deviations from fundamental price will help predict regime switches. Using US data for 1926-89, we find evidence which is consistent with the fads model even when we allow for variation in epxected dividend growth rates and expected discount rates. However, the restrictions which the fads model implies for a more general switching model are rejected. The rejections point in the direction of the bubbles model, although not all the implications of the bubbles model are supported by the data.
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Paper provided by EconWPA in its series Econometrics with number
9502004.
Length: 52 pages Date of creation: 07 Feb 1995 Date of revision:
06 Jun 1995 Handle: RePEc:wpa:wuwpem:9502004
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Article
Simon van Norden & Huntley Schaller, 2002.
"Fads or bubbles?,"
Empirical Economics,
Springer, vol. 27(2), pages 335-362.
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Find related papers by JEL classification: C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General C2 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables C4 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics C5 - Mathematical and Quantitative Methods - - Econometric Modeling C8 - Mathematical and Quantitative Methods - - Data Collection and Data Estimation Methodology; Computer Programs
References listed on IDEAS 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.:
De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990.
"Noise Trader Risk in Financial Markets,"
Journal of Political Economy,
University of Chicago Press, vol. 98(4), pages 703-38, August.
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Cutler, David M & Poterba, James M & Summers, Lawrence H, 1991.
"Speculative Dynamics,"
Review of Economic Studies,
Blackwell Publishing, vol. 58(3), pages 529-46, May.
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David M. Cutler & James M. Poterba & Lawrence H. Summers, 1990.
"Speculative Dynamics,"
NBER Working Papers
3242, National Bureau of Economic Research, Inc.
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Culter, D.M. & Poterba, J.M. & Summers, L.H., 1990.
"Speculative Dynamics,"
Working papers
544, Massachusetts Institute of Technology (MIT), Department of Economics.
Scharfstein, David. & Stein, Jeremy C., 1988.
"Herd behavior and investment,"
Working papers
WP 2062-88., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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Franklin Allen & Gary Gorton, 1991.
"Rational Finite Bubbles,"
NBER Working Papers
3707, National Bureau of Economic Research, Inc.
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