Speculative Bubbles in Stock Prices? Tests Based on the Price-Dividend Ratio

Abstract

Building on the framework from Cochrane (1992), we construct a bootstrap test for rational stock price bubbles that does not require a detailed specification of an underlying equilibrium model. The test makes use of the fact that if there are no bubbles, the variance of the price-dividend ratio can be decomposed into covariances between the price-dividend ratio, and future dividend growth and stock returns, respectively. We use standard bootstrap techniques to compute finite-sample p-values for the null hypothesis that this variance/covariance restriction holds. The test is applied on US stock market data over the period 1871-2002. We also test for unit roots in the price-dividend ratio, and in contrast to standard practice we explicitly consider the explosive alternative in addition to the usual stationary alternative. We find that up to the late 1980s, there are no strong indications of bubbles in US stock prices. However, by including data from the 1990s, there is some evidence of the presence of speculative bubbles.