Testing for Stock Price Bubbles: A Review of Econometric Tools

Abstract

This paper presents an overview of several econometric tools available to test for the presences of asset price bubbles. For demonstrative purpose, the tools were applied to historical stock price and dividend data starting from 1871 through 2014. The earliest tools developed were Shiller’s variance bound tests and West’s two step procedure. Though these tools are useful in detecting asset prices, they are subject to some serious econometric issues. To address these limitations, Cointegration methods were used to detect asset price bubbles. Unfortunately, if there are collapsing bubbles, Cointegration techniques cannot identify multiple bubbles. To overcome this Phillips, Shi and Yu (2015) developed a right tailed Augmented Dickey-Fuller test. This test not only identifies multiple bubbles but also dates the starting and ending period of a bubble. Availability of such real time monitoring tool would significantly help investors, retirees, and portfolio managers to rebalance their portfolios during such bubble periods.

Keywords: Stock Price Bubble, Cointegration, and Right tail ADF

JEL Classification: G12, G14