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Riding Bubbles
Nadja Guenster Maastricht University, Department of Finance; Erasmus University Rotterdam (EUR) - Department of Financial Management Erik Kole Erasmus University Rotterdam (EUR) - Econometric Institute - Erasmus School of Economics; Erasmus Research Institute of Management (ERIM) - Joint Research Institute of Rotterdam School of Management (RSM) and Erasmus School of Economics (ESE), EUR Ben Jacobsen Massey University - Department of Economics and Finance, Albany; New Zealand Institute of Advanced Study October 9, 2009 Paris December 2007 Finance International Meeting AFFI-EUROFIDAI Paper Abstract: We empirically analyze rational investors' optimal response to asset price bubbles. We define bubbles as a sudden acceleration of price growth beyond the growth in fundamental value given by an asset pricing model. Our new bubble detection method requires only a limited time-series of historical returns. We apply our method to US industries and find strong statistical and economic support for the riding bubbles hypothesis: when an investor detects a bubble, her optimal portfolio weight increases significantly. A dynamic riding bubble strategy that uses only real-time information earns abnormal annual returns of 3% to 8%.
Keywords: bubbles, limits to arbitrage, market efficiency, structural breaks JEL Classifications: G10, G14, C14 Working Paper SeriesDate posted: March 17, 2008 ; Last revised: November 20, 2009Suggested CitationContact Information
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