A Real-Time Analysis of Fundamentals and Bubbles in the S&P 500

Standard empirical methods for the identification of rational bubbles in asset markets solely rely on examining explosive time series behavior but do not contain any additional information about the fundamental value and the bubble component. However, obtaining an explicit fundamental solution gives a reasonable starting point for estimating these two components simultaneously. In a decomposition approach on monthly S&P 500 stock data from 1871 to 2023, I highlight the importance of market participant’s changing information set over time, leading to estimation results that fit the underlying data much better than in an ex-post analysis. Bubbles become analyzable not only on grounds of explosive time series behavior, but also in terms of their size. I further derive a bubble cycle that depicts periods with autoregressive patterns relatable to bubbles. Moreover, by engaging a growth rate perspective, real price growth rates become attributable to fundamental and non-fundamental bubble factors.