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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
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    References listed on IDEAS

    as
    1. Kenneth D. West, 1987. "A Specification Test for Speculative Bubbles," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 102(3), pages 553-580.
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    5. 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.
    6. 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.
    7. 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.
    8. Olivier J. Blanchard & Mark W. Watson, 1982. "Bubbles, Rational Expectations and Financial Markets," NBER Working Papers 0945, National Bureau of Economic Research, Inc.
    9. J. Carlos Escanciano & Ignacio N. Lobato, 2009. "Testing the Martingale Hypothesis," Palgrave Macmillan Books, in: Terence C. Mills & Kerry Patterson (ed.), Palgrave Handbook of Econometrics, chapter 20, pages 972-1003, Palgrave Macmillan.
    10. 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.
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    12. Driffill, John & Sola, Martin, 1998. "Intrinsic bubbles and regime-switching," Journal of Monetary Economics, Elsevier, vol. 42(2), pages 357-373, July.
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    14. 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.
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    Full references (including those not matched with items on IDEAS)

    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

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    More about this item

    Keywords

    speculative rational bubbles; martingale tests; fundamental value; dividend expectation;
    All these keywords.

    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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