On Testing for Speculative Bubbles

Abstract

The possibility that movements in prices could be due to the self-fulfilling prophecies of market participants has long intrigued observers of free markets. This paper surveys the current state of the empirically-oriented literature concerning rational dynamic indeterminacies, by which we mean a situation of self-fulfilling prophecy within a rational expectations model. Empirical work in this area concentrates primarily on indeterminacies in price levels, exchange rates, and equity prices. We first examine a particular type of explosive indeterminacy, usually called a rational bubble, in an example of the market for equities. Then, we consider empirical work relating to price-level and exchange-rate indeterminacies and empirical studies of indeterminacies in stock prices. Finally, we take up some interpretive issues.

Testing for a Housing Bubble at the National and Regional Level: The Case of Israel

“…Proving the existence of bubbles can also serve as a tool for discriminating between models (Flood and Hodrick, 1990).…”

“…(9). See Flood and Hodrick (1990) for an early survey of the literature and Gürkaynak (2008) for an updated survey of econometric tests for bubbles. Other examples for bubble test methods include the variance bounds test (LeRoy and Porter, 1981;Shiller, 1981), West's two-step tests (West, 1987) and the intrinsic bubbles test (Froot and Obstfeld, 1992). periodically collapsing bubble, i.e., a bubble that repeatedly emerges and bursts (but remains at positive levels at all times).…”

Residential Buildings and the Cost of Construction: New Evidence on the Efficiency of the Housing Market

“…In that sense, Meese and Wallace recognize that their findings could reflect misspecification of the model and do not provide concrete evidence either in favor of or against the notion that real estate prices might periodically diverge from fundamental values. More generally, all of the studies cited above potentially suffer from Flood and Hodrick's (1990) critique noted earlier. 6 In the present paper, transactions costs are measured by the time to complete a new building.…”

“…As noted by Stiglitz (1990), a common response to the absence of direct information about fundamental values has been to seek indirect empirical evidence for violations of the present value relationship. 1 Partly for that reason, however, Flood and Hodrick (1990) argue that studies proporting to show that asset prices do not satisfy the present value relationship likely suffer from model misspecification, and, as such, do not provide evidence that asset markets are inefficient.…”

Bubbles and Investment Horizons

“…While such exuberant growth is present in all bubble models, we tie it directly to an asset pricing model like the CAPM or a multi-factor model. We do not assume that the fundamental growth rate is simply given, as is typical for the theoretical rational bubble literature (see, for example, Blanchard and Watson, 1982), nor do we tie it to dividends as many articles on testing for bubbles propose (see Flood and Hodrick, 1990, for an overview).…”