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A Direct Test of Rational Bubbles

Author

Listed:
  • Friedrich Geiecke
  • Mark Trede

Abstract

The recent introduction of new derivatives with future dividend payments as underlyings allows to construct a direct test of rational bubbles. We suggest a simple, new method to calculate the fundamental value of stock indices. Using this approach, bubbles become observable. We calculate the time series of the bubble component of the Euro-Stoxx 50 index and investigate its properties. Using a formal hypothesis test we find that the behavior of the bubble is compatible with rationality.

Suggested Citation

  • Friedrich Geiecke & Mark Trede, 2010. "A Direct Test of Rational Bubbles," CQE Working Papers 1310, Center for Quantitative Economics (CQE), University of Muenster.
  • Handle: RePEc:cqe:wpaper:1310
    as

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    File URL: https://www.wiwi.uni-muenster.de/cqe/sites/cqe/files/CQE_Paper/CQE_WP_13_2010.pdf
    File Function: Version of March, 2010
    Download Restriction: no

    References listed on IDEAS

    as
    1. Refet S. Gürkaynak, 2008. "Econometric Tests Of Asset Price Bubbles: Taking Stock ," Journal of Economic Surveys, Wiley Blackwell, vol. 22(1), pages 166-186, February.
    2. Campbell, J.Y. & Shiller, R.J., 1988. "Stock Prices, Earnings And Expected Dividends," Papers 334, Princeton, Department of Economics - Econometric Research Program.
    3. Grossman, Sanford J & Shiller, Robert J, 1981. "The Determinants of the Variability of Stock Market Prices," American Economic Review, American Economic Association, vol. 71(2), pages 222-227, May.
    4. Martin Dufwenberg & Tobias Lindqvist & Evan Moore, 2005. "Bubbles and Experience: An Experiment," American Economic Review, American Economic Association, vol. 95(5), pages 1731-1737, December.
    5. Diba, Behzad T & Grossman, Herschel I, 1988. "Explosive Rational Bubbles in Stock Prices?," American Economic Review, American Economic Association, vol. 78(3), pages 520-530, June.
    6. Driffill, John & Sola, Martin, 1998. "Intrinsic bubbles and regime-switching," Journal of Monetary Economics, Elsevier, vol. 42(2), pages 357-373, July.
    7. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-436, June.
    8. Evans, George W, 1991. "Pitfalls in Testing for Explosive Bubbles in Asset Prices," American Economic Review, American Economic Association, vol. 81(4), pages 922-930, September.
    9. Manuel Dominguez & Ignacio Lobato, 2003. "Testing the Martingale Difference Hypothesis," Econometric Reviews, Taylor & Francis Journals, vol. 22(4), pages 351-377.
    10. Kenneth D. West, 1987. "A Specification Test for Speculative Bubbles," The Quarterly Journal of Economics, Oxford University Press, vol. 102(3), pages 553-580.
    11. Deo, Rohit S., 2000. "Spectral tests of the martingale hypothesis under conditional heteroscedasticity," Journal of Econometrics, Elsevier, vol. 99(2), pages 291-315, December.
    12. Campbell, John Y & Shiller, Robert J, 1988. " Stock Prices, Earnings, and Expected Dividends," Journal of Finance, American Finance Association, vol. 43(3), pages 661-676, July.
    13. Kuan Chung-Ming & Lee Wei-Ming, 2004. "A New Test of the Martingale Difference Hypothesis," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 8(4), pages 1-26, December.
    14. Froot, Kenneth A & Obstfeld, Maurice, 1991. "Intrinsic Bubbles: The Case of Stock Prices," American Economic Review, American Economic Association, vol. 81(5), pages 1189-1214, December.
    15. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
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    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Are bubbles observable?
      by Economic Logician in Economic Logic on 2010-06-01 20:01:00
    2. Weekly Wisdom Roundup # 81 – The Smartest Linkfest On The Web
      by Miguel in Simoleon Sense on 2010-06-07 00:53:02

    More about this item

    Keywords

    speculative rational bubbles; martingale tests; fundamental value; dividend expectation;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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    1. Economic Logic blog

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