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Rational bubbles in stock prices?

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Abstract

This paper reports empirical tests for the existence of rational bubbles in stock prices. The analysis focuses on a familiar model that defines market fundamentals to be the expected present value of dividends, discounted at a constantrate, and defines a rational bubble to be a self-confirming divergence of stock prices from market fundamentals in response to extraneous variables. The tests are based on the theoretical result that, if rational bubbles exist, time series obtained by differencing real stock prices do not have stationary means. Analysis of the data in both the time domain and the frequency domain suggests that the time series of aggregate real stock prices is nonstationary in levels but stationary in first differences. Applications of the time domain tests to simulated nonstationary time series that would be implied by rational bubbles indicates that the tests have power to detect relevant nonstationarity when it is present. Furthermore, application of the time-domain and frequency-domain tests to the time series of aggregate real dividends also indicates nonstationarity in levels but stationarity in first differences -- suggesting that market fundamentals can account for the stationarity properties of real stock prices. These findings imply that rational bubbles do not exist in stock prices. Accordingly,any evidence that stock price fluctuations do not accord with market fundamentals (asspecified above) is attributable to misspecification of market fundamentals.
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Suggested Citation

  • Behzad T. Diba & Herschel I. Grossman, 1987. "Rational bubbles in stock prices?," Working Papers 87-20, Federal Reserve Bank of Philadelphia.
    • Handle: RePEc:fip:fedpwp:87-20
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    Cited by:

    1. Su, Chi-Wei & Wang, Kai-Hua & Chang, Hsu-Ling & Dumitrescu–Peculea, Adelina, 2017. "Do iron ore price bubbles occur?," Resources Policy, Elsevier, vol. 53(C), pages 340-346.
    2. Xin Li & Chi-Wei Su & Meng Qin & Fahai Zhao, 2020. "Testing for Bubbles in the Chinese Art Market," SAGE Open, , vol. 10(1), pages 21582440199, January.
    3. Zeren Feyyaz & Yilanci Veli, 2019. "Are there Multiple Bubbles in the Stock Markets? Further Evidence from Selected Countries," Ekonomika (Economics), Sciendo, vol. 98(1), pages 81-95, June.
    4. Ozan Hatipoglu & Onur Uyar, 2012. "Do Bubbles Spill Over? Estimating Financial Bubbles in Emerging Markets," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 48(S5), pages 64-75, November.
    5. Peter C. B. Phillips & Jun Yu, 2011. "Dating the timeline of financial bubbles during the subprime crisis," Quantitative Economics, Econometric Society, vol. 2(3), pages 455-491, November.
    6. Cerruti, Gianluca & Lombardini, Simone, 2022. "Financial bubbles as a recursive process lead by short-term strategies," International Review of Economics & Finance, Elsevier, vol. 82(C), pages 555-568.
    7. Esteban Gómez & Sandra Rozo, 2008. "Beyond Bubbles: The Role of Asset Prices in Early-Warning Indicators," Revista ESPE - Ensayos Sobre Política Económica, Banco de la República, vol. 26(56), pages 114-148.
    8. Catherine Araujo Bonjean & Catherine Simonet, 2016. "Are grain markets in Niger driven by speculation?," Oxford Economic Papers, Oxford University Press, vol. 68(3), pages 714-735.

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