Rational Bubbles in Stock Prices?

Abstract

Popular commentators as well as professional economists-see, for example, Keynes (1936, pp. 154-155)-have long entertained the idea that movements in stock prices can involve "bubbles"-that is, psychologically based responses to extraneous factors. More recently, theorists using the assumption of rational expectations have analyzed formally the formation of asset prices, their incorporation of market fundamentals, and the possible influence of factors that are not part of market fundamentals. In an earlier paper-Diba and Grossman (1985)-we develop a general theoretical case, summarized briefly below, against the existence of rational bubbles. The present paper reports complementary empirical evidence that fluctuations in American stock prices do not incorporate rational bubbles.

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

“…Hence, when b t 0, the log bubble component grows at rate g in expectations, where g e (r−p) > 0. Diba and Grossman (1988a) point out another implication of the model, namely, that b t can be either zero at all times or positive at all times. To see why, note that a negative value of b t today implies that investors expect a future price of zero.…”

“…Diba and Grossman (1988a) were among the rst to suggest testing for bubbles by using unit root and cointegration tests on stock prices and dividends. They nd that stock prices and dividends are integrated of the same order (one) and that they are cointegrated.…”

“…Using regional-level data accounts This paper does not attempt to answer the question of whether or not there is a problem of a ordability, i.e., whether housing prices are too high relative to income. Diba and Grossman (1988a) were among the rst to argue that given a constant discount factor, identifying explosive characteristics in stock prices is equivalent to detecting a bubble.…”

Applying Approximate Entropy (ApEn) to Speculative Bubble in the Stock Market

“…Test for non-stationarity and cointegration developed by Diba and Grossman (1988) also gained importance in the following years. These techniques however are criticized for their low predictive power and their limitations in the study of speculative bubbles.…”

Signalling the Dotcom bubble: A multiple changes in persistence approach

“…Academic research investigating the existence of bubbles in stock markets is quite extensive (e.g., Campbell andShiller, 1987, 1988;Diba and Grossman, 1988;Froot and Obstfeld, 1991;Craine, 1993;Timmermann, 1995;Crowder and Wohar, 1998;Lamont, 1998;Thaler, 1999;Shiller, 2000b;Cooper et al, 2001;Ritter and Welch, 2002;Ofek and Richardson, 2002;Lamont and Thaler, 2003;Brunnermeier and Nagel, 2004;Sollis, 2006;Hong and Stein , 2007;Stiglitz, 2009;Gutierrez, 2011;and Griffin et al, 2011;Philips, Shi and Yu, 2012, among others) 3 .…”