Handbooks of Research Methods and Applications series
Edited by Adrian R. Bell, Chris Brooks and Marcel Prokopczuk
Chapter 3: Testing for speculative bubbles in asset prices
Like the prices of assets themselves, interest in speculative bubbles as a research topic moves in cycles. At the time of writing (early 2012), it is a hot topic. Currently, much popular discussion is made of the possibility of bubbles in Chinese real estate prices and precious metal commodities; but, it is argued, bubbles in Western stock and real estate markets have already collapsed, leading to heavy financial losses for some and precipitating deep recessions around the world. Bubbles are certainly not new phenomena, and have been argued to have existed for centuries; examples of very early bubbles include ‘tulipmania’ (see Garber, 1989, 2000) and the South Sea Bubble (Garber, 2000; Dale et al., 2005, 2007). Some early approaches to testing for bubbles were implicitly based on the premise that such behaviour in price series can only be caused by investor irrationality. During the growth phase of the bubble, it is argued that investors become ‘irrationally exuberant’, caught up in their own overenthusiasm such that they become willing to pay too much for assets. Eventually, something (probably a minor outside event) triggers a change in sentiment that causes a rapid reduction in prices and the bubble collapses.
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