When bubbles burst: econometric tests based on structural breaks
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Speculative bubbles have played an important role ever since in financial economics. During an ongoing bubble it is relevant for investors and policy-makers to know whether the bubble continues to grow or whether it is already collapsing. Prices are typically well approximated by a random walk in absence of bubbles, while periods of bubbles are characterised by explosive price paths. In this paper we first propose a conventional Chow-type testing procedure for a structural break from an explosive to a random walk regime. It is shown that under the null hypothesis of a mildly explosive process a suitably modified Chow-type statistic possesses a standard normal limiting distribution. Second, a monitoring procedure based on the CUSUM statistic is suggested. It timely indicates such a structural change. Asymptotic results are derived and small-sample properties are studied via Monte Carlo simulations. Finally, two empirical applications illustrate the merits and limitations of our suggested procedures.
KeywordsSpeculative bubbles Structural breaks Mildly explosive processes Monitoring
JEL ClassificationC12 (Hypothesis Testing) C22 (Time-Series Models) G10 (General Financial Markets)
We would like to thank an anonymous referee and a Guest Editor for their helpful comments. Robinson Kruse gratefully acknowledges financial support from CREATES funded by the Danish National Research Foundation.
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