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Regime Switching as a Test for Exchange Rate Bubbles

  • van Norden, Simon

This paper develops a new test for speculative bubbles, which is applied to data for the Japanese yen, the German mark and the Canadian dollar exchange rates from 1977 to 1991. The test assumes that bubbles display a particular kind of regime-switching behaviour, which is shown to imply coefficient restrictions on a simple switching-regression model of exchange rate innovations. Test results are sensitive to the specification of exchange rate fundamentals and other factors. Evidence most consistent with the bubble hypothesis is found using an overshooting model of the Canadian dollar and a PPP model of the Japanese yen. Copyright 1996 by John Wiley & Sons, Ltd.

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Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 11 (1996)
Issue (Month): 3 (May-June)
Pages: 219-51

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Handle: RePEc:jae:japmet:v:11:y:1996:i:3:p:219-51
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  1. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
  2. Jeffrey Frankel and Kenneth Froot., 1991. "Exchange Rate Forecasting Techniques, Survey Data, and Implications for the Foreign Exchange Market," Economics Working Papers 91-158, University of California at Berkeley.
  3. Meese, Richard A, 1986. "Testing for Bubbles in Exchange Markets: A Case of Sparkling Rates?," Journal of Political Economy, University of Chicago Press, vol. 94(2), pages 345-73, April.
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  12. Kenneth D. West, 1986. "A Standard Monetary Model and the Variability of the Deutschemark-DollarExchange Rate," NBER Working Papers 2102, National Bureau of Economic Research, Inc.
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  17. Lewis, Karen K, 1989. "Changing Beliefs and Systematic Rational Forecast Errors with Evidence from Foreign Exchange," American Economic Review, American Economic Association, vol. 79(4), pages 621-36, September.
  18. Takatoshi Ito, 1988. "Foreign Exchange Rate Expectations: Micro Survey Data," NBER Working Papers 2679, National Bureau of Economic Research, Inc.
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  20. Blanchard, Olivier Jean, 1979. "Speculative bubbles, crashes and rational expectations," Economics Letters, Elsevier, vol. 3(4), pages 387-389.
  21. Kiefer, Nicholas M, 1978. "Discrete Parameter Variation: Efficient Estimation of a Switching Regression Model," Econometrica, Econometric Society, vol. 46(2), pages 427-34, March.
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  23. Willem H. Buiter & Paolo A. Pesenti, 1990. "Rational Speculative Bubbles in an Exchange Rate Target Zone," NBER Working Papers 3467, National Bureau of Economic Research, Inc.
  24. Van Norden, S. & Schaller, H., 1996. "Speculative Behaviour, Regime-Switching and Stock Market Crashes," Staff Working Papers 96-13, Bank of Canada.
  25. Flood, Robert P & Hodrick, Robert J, 1990. "On Testing for Speculative Bubbles," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 85-101, Spring.
  26. Tucker, Alan L & Pond, Lallon, 1988. "The Probability Distribution of Foreign Exchange Price Changes: Tests of Candidate Processes," The Review of Economics and Statistics, MIT Press, vol. 70(4), pages 638-47, November.
  27. Behzad T. Diba & Herschel I. Grossman, 1987. "On the Inception of Rational Bubbles," The Quarterly Journal of Economics, Oxford University Press, vol. 102(3), pages 697-700.
  28. Charles Engel & James D. Hamilton, 1989. "Long Swings in the Exchange Rate: Are they in the Data and Do Markets Know It?," NBER Working Papers 3165, National Bureau of Economic Research, Inc.
  29. Frankel, Jeffrey A & Froot, Kenneth A, 1987. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," American Economic Review, American Economic Association, vol. 77(1), pages 133-53, March.
  30. James M. Poterba & Lawrence H. Summers, 1987. "Mean Reversion in Stock Prices: Evidence and Implications," NBER Working Papers 2343, National Bureau of Economic Research, Inc.
  31. Jeffrey R. Shafer & Bonnie E. Loopesko, 1983. "Floating Exchange Rates after Ten years," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 14(1), pages 1-86.
  32. Cecchetti, Stephen G & Lam, Pok-sang & Mark, Nelson C, 1990. "Mean Reversion in Equilibrium Asset Prices," American Economic Review, American Economic Association, vol. 80(3), pages 398-418, June.
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  34. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
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  36. Lee, Lung-Fei & Porter, Robert H, 1984. "Switching Regression Models with Imperfect Sample Separation Information-With an Application on Cartel Stability," Econometrica, Econometric Society, vol. 52(2), pages 391-418, March.
  37. Akgiray, Vedat & Booth, G Geoffrey, 1988. "Mixed Diffusion-Jump Process Modeling of Exchange Rate Movements," The Review of Economics and Statistics, MIT Press, vol. 70(4), pages 631-37, November.
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