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Testing for a rational bubble under long memory

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  • M. FRÖMMEL

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  • R. KRUSE

Abstract

We analyze the time series properties of the S&P500 dividend-price ratio in the light of long memory, structural breaks and rational bubbles. We find an increase in the long memory parameter in the early 1990s by applying a recently proposed test by Sibbertsen and Kruse (2009). An application of the unit root test against long memory by Demetrescu et al. (2008) suggests that the pre-break data can be characterized by long memory, while the post-break sample contains a unit root. These results reconcile two empirical findings which were seen as contradictory so far: on the one hand they confirm the existence of fractional integration in the S&P500 log dividend-price ratio and on the other hand they are consistent with the existence of a rational bubble. The result of a changing memory parameter in the dividend-price ratio has an important implication for the literature on return predictability: the shift from a stationary dividend-price ratio to a unit root process in 1991 is likely to have caused the well-documented failure of conventional return prediction models since the 1990s.

Suggested Citation

  • M. Frömmel & R. Kruse, 2011. "Testing for a rational bubble under long memory," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 11/722, Ghent University, Faculty of Economics and Business Administration.
  • Handle: RePEc:rug:rugwps:11/722
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    File URL: http://wps-feb.ugent.be/Papers/wp_11_722.pdf
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    Cited by:

    1. Bond, Derek & Gallagher, Emer & Ramsey, Elaine, 2012. "A preliminary investigation of northern Ireland's housing market dynamics," MPRA Paper 39806, University Library of Munich, Germany.
    2. Jörg Breitung & Robinson Kruse, 2013. "When bubbles burst: econometric tests based on structural breaks," Statistical Papers, Springer, vol. 54(4), pages 911-930, November.
    3. Baur, Dirk G. & Glover, Kristoffer J., 2015. "Speculative trading in the gold market," International Review of Financial Analysis, Elsevier, vol. 39(C), pages 63-71.
    4. Sibbertsen, Philipp & Wegener, Christoph & Basse, Tobias, 2014. "Testing for a break in the persistence in yield spreads of EMU government bonds," Journal of Banking & Finance, Elsevier, vol. 41(C), pages 109-118.

    More about this item

    Keywords

    Rational bubbles; dividend-price ratio; fractional integration; changing persistence.;

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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