Publication Type

Working Paper

Version

publishedVersion

Publication Date

11-2009

Abstract

A recursive test procedure is suggested that provides a mechanism for testing explosive behavior, date-stamping the origination and collapse of economic exuberance, and providing valid confidence intervals for explosive growth rates. The method involves the recursive implementation of a right-side unit root test and a sup test, both of which are easy to use in practical applications, and some new limit theory for mildly explosive processes. The test procedure is shown to have discriminatory power in detecting periodically collapsing bubbles, thereby overcoming a weakness in earlier applications of unit root tests for economic bubbles. Some asymptotic properties of the Evans (1991) model of periodically collapsing bubbles are analyzed and the paper develops a new model in which bubble duration depends on the strength of the cognitive bias underlying herd behavior in the market. The paper also explores alternative propagating mechanisms for explosive behavior based on economic fundamentals under time varying discount rates. An empirical application to the Nasdaq stock price index in the 1990s provides confirmation of explosiveness and date-stamps the origination of financial exuberance to June 1995, prior to the famous remark in December 1996 by Alan Greenspan about irrational exuberance in financial markets, thereby giving the remark empirical content.

Keywords

Explosive root, irrational exuberance, mildly explosive process, Nasdaq bubble, periodically collapsing bubble, sup test, unit root test

Discipline

Econometrics | Finance

Research Areas

Econometrics

First Page

1

Last Page

37

Publisher

SMU Economics and Statistics Working Paper Series, No. 19-2009

City or Country

Singapore

Copyright Owner and License

Authors

Comments

Published in International Economic Review, 2011, https://doi.org/10.1111/j.1468-2354.2010.00625.x

Download

Share

COinS