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Detecting stock market bubbles based on the cross-sectional dispersion of stock prices

Author

Listed:
  • Takayuki Mizuno

    (National Institute of Informatics)

  • Takaaki Ohnishi

    (Graduate School of Information Science and Technology, University of Tokyo)

  • Tsutomu Watanabe

    (Graduate School of Economics, University of Tokyo)

Abstract

A statistical method is proposed for detecting stock market bubbles that occur when speculative funds concentrate on a small set of stocks. The bubble is defined by stock price diverging from the fundamentals. A firm’s financial standing is certainly a key fundamental attribute of that firm. The law of one price would dictate that firms of similar financial standing share similar fundamentals. We investigate the variation in market capitalization normalized by fundamentals that is estimated by Lasso regression of a firm’s financial standing. The market capitalization distribution has a substantially heavier upper tail during bubble periods, namely, the market capitalization gap opens up in a small subset of firms with similar fundamentals. This phenomenon suggests that speculative funds concentrate in this subset. We demonstrated that this phenomenon could have been used to detect the dot-com bubble of 1998-2000 in different stock exchanges.

Suggested Citation

  • Takayuki Mizuno & Takaaki Ohnishi & Tsutomu Watanabe, 2019. "Detecting stock market bubbles based on the cross-sectional dispersion of stock prices," Working Papers on Central Bank Communication 010, University of Tokyo, Graduate School of Economics.
    • Handle: RePEc:upd:utmpwp:010
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    References listed on IDEAS

    as
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    5. Takaaki Ohnishi & Takayuki Mizuno & Tsutomu Watanabe, 2019. "House Price Dispersion in Boom-Bust Cycles: Evidence from Tokyo," CARF F-Series CARF-F-461, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
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    10. Takayuki Mizuno & Takaaki Ohnishi & Tsutomu Watanabe, 2016. "Power laws in market capitalization during the dot-com and Shanghai bubble periods," Evolutionary and Institutional Economics Review, Springer, vol. 13(2), pages 445-454, December.
    11. Mizuno, Takayuki & Ohnishi, Takaaki & Watanabe, Tsutomu, 2016. "Power law in market capitalization during Dot-com and Shanghai bubble periods," HIT-REFINED Working Paper Series 60, Institute of Economic Research, Hitotsubashi University.
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    Keywords

    Stock market; Financial bubble; Nowcast; Power law;
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