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Testing for rational bubbles in a co-explosive vector autoregression

  • Tom Engsted

    ()

    (CREATES, School of Economics and Management, Aarhus University, DK-8000 Aarhus C)

  • Bent Nielsen

    ()

    (Nuffield College, Oxford OX1 1NF, U.K.)

We derive the parameter restrictions that a standard equity market model implies for a bivariate vector autoregression for stock prices and dividends, and we show how to test these restrictions using likelihood ratio tests. The restrictions, which imply that stock returns are unpredictable, are derived both for a model without bubbles and for a model with a rational bubble. In both cases we show how the restrictions can be tested through standard chi-squared inference. The analysis for the no-bubble case is done within the traditional Johansen model for I(1) variables, while the bubble model is analysed using a co-explosive framework. The methodology is illustrated using US stock prices and dividends for the period 1872-2000.

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File URL: http://www.nuffield.ox.ac.uk/economics/papers/2010/w6/bubble24juni10.pdf
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Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2010-W06.

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Length: 54 pages
Date of creation: 24 Jun 2010
Date of revision:
Handle: RePEc:nuf:econwp:1006
Contact details of provider: Web page: http://www.nuff.ox.ac.uk/economics/

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  1. Bent Nielsen & Anders Rahbek, 2003. "Similarity Issues in Cointegration Models," Economics Series Working Papers 1998-W13, University of Oxford, Department of Economics.
  2. Diba, Behzad T & Grossman, Herschel I, 1988. "Explosive Rational Bubbles in Stock Prices?," American Economic Review, American Economic Association, vol. 78(3), pages 520-30, June.
  3. Engsted, Tom, 2006. "Explosive bubbles in the cointegrated VAR model," Finance Research Letters, Elsevier, vol. 3(2), pages 154-162, June.
  4. Breusch, T S, 1978. "Testing for Autocorrelation in Dynamic Linear Models," Australian Economic Papers, Wiley Blackwell, vol. 17(31), pages 334-55, December.
  5. H. Peter Boswijk & Jurgen A. Doornik, 2004. "Identifying, estimating and testing restricted cointegrated systems: An overview," Statistica Neerlandica, Netherlands Society for Statistics and Operations Research, vol. 58(4), pages 440-465.
  6. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
  7. Evans, George W, 1991. "Pitfalls in Testing for Explosive Bubbles in Asset Prices," American Economic Review, American Economic Association, vol. 81(4), pages 922-30, September.
  8. Bohl, Martin T., 2003. "Periodically collapsing bubbles in the US stock market?," International Review of Economics & Finance, Elsevier, vol. 12(3), pages 385-397.
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