Avoiding the Pitfalls: Can Regime-Switching Tests Detect Bubbles?
Work on testing for bubbles has caused much debate, much of which has focused on methodology. Monte Carlo simulations reported in Evans (1991) showed that standard tests for unit roots and cointegration frequently reject the presence of bubbles even when such bubbles are present by construction. Evans referred to this problem as the pitfall of testing for bubbles. Since Evans' note, new tests for rational speculative bubbles that rely on regime switching have been proposed. van Norden and Schaller (1993) and van Norden (1996) use a switching regression to look for a time- varying relationship between returns and deviations from an approximate fundamental price. Hall and Sola (1993) and Funke, Hall and Sola (1994) test whether asset prices seem to switch between explosive growth and stationary behaviour. Our paper does Monte Carlo experiments using Evan's data generating process to gauge the performance of these two kinds of regime-switching tests. These rely heavily on new fast robust programs developed at the Bank of Canada for the estimation of switching regression models, which make Monte Carlo studies of such estimators practical. We find that for some (but not all) parameter values, regime-switching tests have significant amount of power to detect periodically collapsing bubbles. We also compare and contrast the performance of the two different regime-switching tests.
|Date of creation:||08 Mar 1996|
|Date of revision:|
|Note:||Paper to be presented at the SNDE meeting in Boston March 16th. Text and Graphs in separate Postscript files. Both files compressed in a single Info-zip archive, then uuencoded.|
|Contact details of provider:|| Web page: http://econwpa.repec.org|
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Bulow, Jeremy & Klemperer, Paul, 1994.
"Rational Frenzies and Crashes,"
Journal of Political Economy,
University of Chicago Press, vol. 102(1), pages 1-23, February.
- Hamilton, James D. & Whiteman, Charles H., 1985. "The observable implications of self-fulfilling expectations," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 353-373, November.
- Froot, Kenneth A & Obstfeld, Maurice, 1991.
"Intrinsic Bubbles: The Case of Stock Prices,"
American Economic Review,
American Economic Association, vol. 81(5), pages 1189-214, December.
- Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
- van Norden, Simon, 1996.
"Regime Switching as a Test for Exchange Rate Bubbles,"
Journal of Applied Econometrics,
John Wiley & Sons, Ltd., vol. 11(3), pages 219-51, May-June.
- Simon van Norden, 1995. "Regime Switching as a Test for Exchange Rate Bubbles," Econometrics 9502001, EconWPA, revised 09 Aug 1995.
- J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, .
"Noise Trader Risk in Financial Markets,"
J. Bradford De Long's Working Papers
_124, University of California at Berkeley, Economics Department.
- Behzad T. Diba & Herschel I. Grossman, 1987. "On the Inception of Rational Bubbles," The Quarterly Journal of Economics, Oxford University Press, vol. 102(3), pages 697-700.
- Kenneth D. West, 1987.
"A Specification Test for Speculative Bubbles,"
The Quarterly Journal of Economics,
Oxford University Press, vol. 102(3), pages 553-580.
- Charemza, Wojciech W. & Deadman, Derek F., 1995. "Speculative bubbles with stochastic explosive roots: The failure of unit root testing," Journal of Empirical Finance, Elsevier, vol. 2(2), pages 153-163, June.
- Funke, Michael & Hall, Stephen & Sola, Martin, 1994.
"Rational bubbles during Poland's hyperinflation: Implications and empirical evidence,"
European Economic Review,
Elsevier, vol. 38(6), pages 1257-1276, June.
- M. Funke & S. Hall & M. Solá, 1993. "Rational bubbles during Polland’s hiperinflation: implications and empirical evidence," Documentos de Trabajo (working papers) 1193, Department of Economics - dECON.
- Simon van Norden & Robert Vigfusson, 1996.
"Regime-Switching Models: A Guide to the Bank of Canada Gauss Procedures,"
- Van Norden, S. & Vigfusson, R., 1996. "Regime-Switching Models, A guide to the Bank of Canada Gauss Procedures," Staff Working Papers 96-3, Bank of Canada.
- Franklin Allen & Gary B. Gorton, .
"Rational Finite Bubbles,"
Rodney L. White Center for Financial Research Working Papers
41-88, Wharton School Rodney L. White Center for Financial Research.
- Obstfeld, Maurice & Rogoff, Kenneth, 1983.
"Speculative Hyperinflations in Maximizing Models: Can We Rule Them Out?,"
Journal of Political Economy,
University of Chicago Press, vol. 91(4), pages 675-87, August.
- Obstfeld, Maurice & Rogoff, Kenneth S., 1983. "Speculative Hyperinflations in Maximizing Models: Can We Rule Them Out?," Scholarly Articles 12491027, Harvard University Department of Economics.
- Maurice Obstfeld & Kenneth Rogoff, 1982. "Speculative Hyperinflations in Maximizing Models: Can We Rule Them Out?," NBER Working Papers 0855, National Bureau of Economic Research, Inc.
- Maurice Obstfeld & Kenneth S. Rogoff, 1981. "Speculative hyperinflations in a maximizing models: can we rule them out?," International Finance Discussion Papers 195, Board of Governors of the Federal Reserve System (U.S.).
- 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.
- van Norden, Simon & Schaller, Huntley, 1993. "The Predictability of Stock Market Regime: Evidence from the Toronto Stock Exchange," The Review of Economics and Statistics, MIT Press, vol. 75(3), pages 505-10, August.
- Van Norden, S. & Schaller, H., 1996.
"Speculative Behaviour, Regime-Switching and Stock Market Crashes,"
Staff Working Papers
96-13, Bank of Canada.
- Simon van Norden & Huntley Schaller & ), 1995. "Speculative Behaviour, Regime-Switching, and Stock Market Crashes," Econometrics 9502003, EconWPA.
- repec:cdl:ucsbec:13-89 is not listed on IDEAS
- Philippe Weil, 1989.
"On The Possibility of Price Decreasing Bubbles,"
NBER Working Papers
2821, National Bureau of Economic Research, Inc.
- C. Gilles & S.F. Leroy, 1989.
"Bublles and Charges,"
Carleton Economic Papers
89-05, Carleton University, Department of Economics, revised May 1992.
- Francis X. Diebold & Joon-Haeng Lee & Gretchen C. Weinbach, 1993. "Regime switching with time-varying transition probabilities," Working Papers 93-12, Federal Reserve Bank of Philadelphia.
- Obstfeld, Maurice & Rogoff, Kenneth, 1986. "Ruling out divergent speculative bubbles," Journal of Monetary Economics, Elsevier, vol. 17(3), pages 349-362, May.
- Alok Bhargava, 1986. "On the Theory of Testing for Unit Roots in Observed Time Series," Review of Economic Studies, Oxford University Press, vol. 53(3), pages 369-384.
- LeRoy, Stephen F, 1989. "Efficient Capital Markets and Martingales," Journal of Economic Literature, American Economic Association, vol. 27(4), pages 1583-1621, December.
- Flood, Robert P & Hodrick, Robert J, 1990. "On Testing for Speculative Bubbles," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 85-101, Spring.
- Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpme:9603001. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA)
If references are entirely missing, you can add them using this form.