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Fads or bubbles?

  • Simon van Norden

    (Service de l'enseignment de la finance, Ecole des H.E.C., 3000 Chemin de la Côte Sainte Catherine, Montreal, QC, Canada H3T 2A7)

  • Huntley Schaller


    (Department of Economics, Carleton University, 1125 Colonel By Drive, Ottawa, Ontario, K1S 5B6, CANADA)

This paper tests between fads and bubbles using a switching regression to distinguish between competing models. Two main features of the bubbles model distinguish it from the fads model. First, the bubbles model implies that returns are drawn from regimes which differ in the way returns vary with deviations from fundamental prices. 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 expected dividend growth rates and expected discount rates. However, the restrictions which the fads model implies for a more general switching-regression specification are rejected. The rejections point in the direction of the bubbles model, although not all of the implications of the bubbles model are supported by the data.

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Article provided by Springer in its journal Empirical Economics.

Volume (Year): 27 (2002)
Issue (Month): 2 ()
Pages: 335-362

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Handle: RePEc:spr:empeco:v:27:y:2002:i:2:p:335-362
Note: Received: October 2000/Final Version Received: October 2001
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