Rational Bubbles Research Articles

Analysing Rational Bubbles in African Stock Markets: Evidence from Econophysics Frequency Domain Estimates and DCC MGARCH Model

Analysing Rational Bubbles in African Stock Markets: Evidence from Econophysics Frequency Domain Estimates and DCC MGARCH Model

Investigating the Existence of a Rational Bubble in the Iranian Currency Market with an Emphasis on the Fundamental Variables of the Exchange Rate

Investigating the Existence of a Rational Bubble in the Iranian Currency Market with an Emphasis on the Fundamental Variables of the Exchange Rate

The Spirit of Capitalism and Rational Bubbles

The Spirit of Capitalism and Rational Bubbles

Rational Bubbles in A Monetary Economy

Rational Bubbles in A Monetary Economy

Asset bubbles and product market competition

This paper studies the interplay between asset bubbles and product market competition. It offers two main insights. The first is that imperfect competition creates a wedge between interest rates and the marginal product of capital. This makes rational bubbles possible even when there is no overaccumulation of capital. The second is that when providing a production subsidy, bubbles stimulate competition and reduce monopoly rents. I show that bubbles can destroy efficient investment and have ambiguous welfare consequences. However, when they stimulate competition, they can have crowding‐in effects on capital.

Optimal monetary policy responses to carbon and green bubbles:A two-sector DSGE analysis

This paper investigates the emergence of carbon and green bubbles and their impacts on macroeconomic performance and the environment, with a particular focus on identifying the optimal monetary policy responses. We construct a two-sector dynamic stochastic general equilibrium (DSGE) model that incorporates monetary policy and allows carbon and green rational bubbles to emerge. We find that while supply-side shocks drive bubble formation in both sectors, demand-side shocks have a disproportionate impact on these sectors. The paper also shows that contractionary monetary policies are effective in reducing both carbon emissions and asset bubbles. Optimal monetary policy response to the emergence of asset bubbles is calculated, emphasizing the crucial role of central banks in designing monetary policy rules that account for the emergence of bubbles. Social welfare can be optimized by reducing annual interest rates by 0.0612% and 0.0512% when green and brown bubble sizes increase by 1%, respectively. Furthermore, the most effective strategy to achieve a significant improvement in social welfare in both the short-run and the long-run is to implement policies where nominal interest rates react negatively to both types of asset bubbles simultaneously. The impacts of carbon taxation and green credit policies on asset bubbles are also studied.

Bubble occurrence and landing

First, a rational bubble with a stochastic crash is modelled under conditions of timelessness (or strictly a zero interest rate) and an infinite number of investors. The necessary and sufficient conditions for this bubble are a strictly positive bubble premium and a sufficient number of investors. Second, it is shown that a rational bubble occurs under a strictly negative interest rate. Finally, whether bubbles can be prevented or landed is discussed.

The real side of stock market exuberance: bubbles, output and productivity at the industry level

AbstractThere has been a growing interest in the theory of rational bubbles. Recent theories predict that bubbles are expansionary, but differ in the underlying mechanisms. This paper provides empirical evidence that helps us to assess different theories, and documents four main findings: stock market overvaluation is associated with (i) faster output and input growth, (ii) declining total factor productivity (TFP) growth, (iii) a greater contribution of labour and a declining contribution of TFP for output growth, (iv) an increase in the number of firms. Overall, these findings suggest that bubbly expansions are driven by increased factor accumulation (in particular labour), and not from higher productivity growth.

Wealth preference and rational bubbles

In this paper, we show that rational bubbles can exist within a neoclassical economy, provided that households derive utility from holding wealth. Hence, we provide a microfoundation for bubbles that relies on a frictionless economy with an infinitely-lived representative household. While our bubbly equilibria are very similar to those obtained by Tirole (1985) in an overlapping generation economy, the underlying mechanism is fundamentally different. Instead of relying on an exchange across heterogeneous households, the bubble relies on the representative household’s willingness to accumulate wealth without the intention of spending it. Turning to public debt, we carefully review the similarities and the differences between rational bubbles and Ponzi schemes. We establish that the Ricardian equivalence must hold in any of our equilibria. Finally, within a monetary economy, we show that the preference for wealth is fundamentally different from money-in-the-utility-function.

Rational bubbles: Too many to be true?

Issues that arise in the practical implementation of the Phillips et al. (2011) and Phillips et al. (2015a) recursive procedures for identifying and dating explosive episodes in time series are considered. It is argued that the use of critical values for right-tailed unit-root tests obtained under the assumption of a drift whose magnitude depends on the sample size and becomes negligible in large samples results in over-rejection of the unit-root hypothesis when, as in many financial time series, the deterministic drift effect is non-negligible relatively to the stochastic trend. In addition, the standard practice of using conventional levels of significance for critical values involved in the algorithms that locate the origination and termination dates of explosive episodes lead to false discoveries of explosiveness with high probability. The magnitude of these difficulties is quantified via simulations using artificial data whose properties reflect closely those of real-world time series such as stock prices and dividends. The findings offer a potential explanation for the relatively large number of apparent explosive episodes that are often reported in applied work. Ways of overcoming the aforementioned difficulties by using bootstrap-based calibration techniques are considered. An empirical example focusing on monthly U.S. data on real stock prices and real dividends is also discussed.

Liquidity and asset market cycles

We develop a theory of boom-bust cycle of rational bubbles capable of replicating some of the stylized patterns of the bubbly episodes which we document. Instead of relying on random investor sentiments to explain the cycle, we use the interplay of liquidity supply and economic fundamentals. Related policy implications are discussed.

On testing for bubbles during hyperinflations

Abstract We consider testing for the presence of rational bubbles during hyperinflations via an analysis of the non-stationarity properties of relevant observable time series. The test procedure is based on a Markov regime-switching model with independent stochastic changes in its intercept, error variance and autoregressive coefficients. This model formulation allow us to disentangle fundamentals-driven changes in the drift, bubble-driven explosiveness, and volatility changes that may be fundamentals-driven and/or bubble-driven. The testing methodology is illustrated by applying it to data from hyperinflations in Argentina, Brazil, Germany and Poland.

Point estimation in sign-restricted SVARs based on independence criteria with an application to rational bubbles

The median and median target estimates in sign-restricted SVARs are driven by a highly informative prior for the set-identified structural parameters. This paper proposes an approach for point elicitation by minimizing the evidence against the null hypothesis of independence with respect to the orthogonalized residuals implied by the identified set. Finite sample properties of the estimator are studied in a Monte Carlo experiment. As an empirical illustration, we analyze monetary policy effects within the rational bubble model of equity valuation (Galí, 2014). The detected monetary policy shocks lead to distinct response profiles of the fundamental and bubble components of asset prices.

Bubbly Economy: Dynamics of Multiple Rational Bubbles

Bubbly Economy: Dynamics of Multiple Rational Bubbles

Estimation on Rational Speculative Bubbles in Stock Market by Using Generalised Johansen-Ledoit-Sornette Model

This paper discusses the generalized Johansen-Ledoit-Sornette (GJLS) model in determining and predicting the size of rational speculative bubbles in stock market. In this study, the GJLS model is used as an approach to detect the presence and prediction of rational speculative bubble sizes of the stock market. The stock markets chosen in this study are Hang Seng, Nikkei 225 and S\&P 500. This is because China, Japan and United States are countries that pioneers the world economy. This paper presents step by step on finding the linear and non-linear parameters in the generalized Johansen-Ledoit-Sornette model using the Ordinary Least Squares method for the linear parameters and formulas for the non-linear parameters. There are 7 parameters that need to be identified which are A,B and C for linear parameter and ω, φ, β and t for the non-linear parameter. Then, the size of speculative rational bubbles is determined and predict using the GJLS model. The size of speculative rational bubbles for future cycle is forecasted. Then, the effect of the presence of rational speculative bubbles towards the economy is discussed.

Examining rational bubbles in global natural gas prices: Evidence from frequency domain estimates

Natural gas plays important role in the global energy sources, hence understanding its price behavior is important to various economic agents. This study examined whether rational bubbles existed in the three major natural gas markets by employing Fourier unit root tests and a nonparametric rank test for cointegration. Data comprises monthly data on the three largest natural gas indices in the world – Henry hub (USA), European and Asian (Japan) for the period from 2000M1–2021M12. The results reveal that the efficient market hypothesis holds in the market ruling out the possibility of arbitrage opportunities. The rank test estimates at 0.009677, 0.009872, and 0.009657 at 1% significant level for the pre-COVID-19 sample period, and at 0.009671, 0.09874, and 0.009661 at 1% significant level for the full sample period contradict the rational explosive bubble framework that suggests deviation of prices from the fundamentals. This suggests that natural gas prices markets are efficient at least in the weak form, the implication is that disruptions in the market will be short-lived as the market will fundamentally adjust back to equilibrium.

Developing a Regime-Switching Present Value Model: Switching Fundamentals and Bubbles

We develop a present-value model where the fundamental and non-fundamental components switch between distinct regimes. The non-fundamental component is specified as a periodically collapsing bubble of Balke and Wohar [Balke, N. S., & Wohar, M. E. (2009). Market fundamentals versus rational bubbles in stock prices: A Bayesian perspective. Journal of Applied Econometrics, 24(1), 35–75. https://doi.org/10.1002/jae.1025]. The fundamental component is constructed as in van Binsbergen and Koijen [van Binsbergen, J. H., & Koijen, R. S. J. (2010). Predictive regressions: A present-value approach. The Journal of Finance, 65(4), 1439–1471. https://doi.org/10.1111/j.1540-6261.2010.01575.x], by treating the expectations of market fundamentals as latent variables. Unlike existing methods, e.g. [Zhu, X. (2015). Tug-of-war: Time-varying predictability of stock returns and dividend growth. Review of Finance, 19(6), 2317–2358. https://doi.org/10.1093/rof/rfu047; Choi, K. H., Kim, C., & Park, C. (2017). Regime shifts in price-dividend ratios and expected stock returns: A present-value approach. Journal of Money, Credit and Banking, 49(2–3), 417–441. https://doi.org/10.1111/jmcb.12384; Chan, J. C., & Santi, C. (2021). Speculative bubbles in present-value models: A Bayesian Markov-switching state space approach. Journal of Economic Dynamics and Control, 127, 1–26], ours requires no unnecessary approximations, accommodates flexible forms of regime-switching, and the resulting present-value formula is internally consistent.

Bubble into reallocation: How bubbles improve capital allocation in China

This paper develops a theoretical framework to shed lights on the relations between the segmented financial market and the housing bubble in China. In our framework, capital misallocation across firms plays a central role. The segmented financial market causes discrimination against private enterprises and favoritism to state-owned firms. This biased financial system not only gives rise to capital misallocation across firms but also significantly pushes down the equilibrium interest rate in the formal financial market. The overly low interest rate in the formal financial market causes a rational bubble in a dynamically efficient economy. More importantly, the bubble improves capital allocation across firms by crowding out inefficient investment in the state-owned sector. Despite the role of improving capital allocation, bubbles may still reduce welfare by crowding out aggregate capital.

Bubbly bailout

We provide a theory to investigate the implications of time-varying bailout policy for rational bubbles in an infinite-horizon production economy. In particular, we ask two questions. First, should the government bailout asset bubbles? Second, if yes, how? In our model, firms face idiosyncratic investment opportunities and financial frictions, and creating new bubbles incurs real resources. Intrinsically useless assets can alleviate firms' credit constraints and enhance investment efficiency with additional liquidity. However, asset bubbles are vulnerable to market sentiment and resource-consuming. The time-varying probability of bubble burst causes both asset price volatility and economic fluctuations. In the presence of this tradeoff, we examine the efficiency and the welfare implications of the time-varying bailout policy. We find that the optimal bailout policy is leaning against the wind, striking a balance between the crowding-in and crowding-out effect.

Can monetary policy lean against housing bubbles?

Gali and Gambetti (2015) found protracted episodes in which stock prices rise in response to monetary policy tightening. This counter-intuitive result suggests that raising the policy rate in response to a perceived asset price deviation from fundamentals may fail to contain an emerging bubble. Since housing is often at the epicenter of deep and protracted recessions, it is essential (from a monetary policy perspective) to assess whether the result from Gali and Gambetti (2015) also holds when one considers housing instead of stock prices. Thus, we estimated a Bayesian VAR model based on an asset-pricing framework allowing for rational bubbles in the United States, the United Kingdom, and Canada. In addition, this estimation framework separates the fundamental component of housing prices from its bubble component, derived as the deviation of observed prices from the fundamental values. This allowed us to examine the responses of both components to a monetary policy shock and assess how bubbles may affect the responses of housing prices to monetary policy tightening. According to the results, we found that housing prices respond negatively to an interest rate hike, as common intuition would imply. This indicates that monetary policy may play a role in fighting housing price bubbles.