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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. Van Norden, S. & Schaller, H., 1996. "Speculative Behaviour, Regime-Switching and Stock Market Crashes," Working Papers 96-13, Bank of Canada.
  2. Franklin Allen & Gary B. Gorton, . "Rational Finite Bubbles," Rodney L. White Center for Financial Research Working Papers 41-88, Wharton School Rodney L. White Center for Financial Research.
  3. 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.
  4. Campbell, John & Clarida, Richard, 1987. "The Dollar and Real Interest Rates," Scholarly Articles 3221495, Harvard University Department of Economics.
  5. 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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  7. Philippe Jorion, 1988. "On Jump Processes in the Foreign Exchange and Stock Markets," Review of Financial Studies, Society for Financial Studies, vol. 1(4), pages 427-445.
  8. Buiter, Willem H. & Pesenti, Paolo, 1990. "Rational Speculative Bubbles in an Exchange Rate Target Zone," CEPR Discussion Papers 479, C.E.P.R. Discussion Papers.
  9. 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.
  10. 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.
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  12. Paul R. Krugman, 1985. "Is the strong dollar sustainable?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 103-155.
  13. 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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  15. Froot, Kenneth A & Obstfeld, Maurice, 1991. "Intrinsic Bubbles: The Case of Stock Prices," American Economic Review, American Economic Association, vol. 81(5), pages 1189-214, December.
  16. Flood, Robert P & Hodrick, Robert J, 1986. " Asset Price Volatility, Bubbles, and Process Switching," Journal of Finance, American Finance Association, vol. 41(4), pages 831-42, September.
  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. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  19. Goldfeld, Stephen M. & Quandt, Richard E., 1973. "A Markov model for switching regressions," Journal of Econometrics, Elsevier, vol. 1(1), pages 3-15, March.
  20. Frankel, Jeff & Froot, Ken, 1986. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," Department of Economics, Working Paper Series qt1972q8wm, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  21. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
  22. Weil, Philippe, 1990. "On the Possibility of Price Decreasing Bubbles," Econometrica, Econometric Society, vol. 58(6), pages 1467-74, November.
  23. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
  24. Gilles, Christian & LeRoy, Stephen F, 1992. "Bubbles and Charges," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 33(2), pages 323-39, May.
  25. 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.
  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. Diba, Behzad T & Grossman, Herschel I, 1987. "On the Inception of Rational Bubbles," The Quarterly Journal of Economics, MIT Press, vol. 102(3), pages 697-700, August.
  28. Takatoshi Ito, 1988. "Foreign Exchange Rate Expectations: Micro Survey Data," NBER Working Papers 2679, National Bureau of Economic Research, Inc.
  29. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
  30. Obstfeld, Maurice & Rogoff, Kenneth, 1986. "Ruling out divergent speculative bubbles," Journal of Monetary Economics, Elsevier, vol. 17(3), pages 349-362, May.
  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. Kiefer, Nicholas M, 1978. "Discrete Parameter Variation: Efficient Estimation of a Switching Regression Model," Econometrica, Econometric Society, vol. 46(2), pages 427-34, March.
  33. Jeffrey A. Frankel & Kenneth Froot, 1990. "Exchange Rate Forecasting Techniques, Survey Data, and Implications for the Foreign Exchange Market," NBER Working Papers 3470, National Bureau of Economic Research, Inc.
  34. Blanchard, Olivier Jean, 1979. "Speculative bubbles, crashes and rational expectations," Economics Letters, Elsevier, vol. 3(4), pages 387-389.
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  36. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  37. 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.
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