Asset Price Volatility, Bubbles, and Process Switching

26 Pages Posted: 4 Apr 2004 Last revised: 10 Aug 2022

See all articles by Robert P. Flood

Robert P. Flood

International Monetary Fund (IMF) - Research Department; CENTRUM Business School; National Bureau of Economic Research (NBER)

Robert J. Hodrick

Columbia University - Columbia Business School, Finance; National Bureau of Economic Research (NBER)

Date Written: March 1986

Abstract

Evidence of excess volatilities of asset prices compared with those of market fundamentals is often attributed to speculative bubbles. This study examines the sense in which speculative bubbles could in theory lead to excess volatility, hut it demonstrates that some of the variance hounds evidence reported to date precludes bubbles as a reason why asset prices might violate such hounds. The findings must represent some other model misspecffication or market inefficiency. One important misspecification occurs when there searcher incorrectly specifies the time series properties of market fundamentals. A bubble-free example economy characterized by a potential switch in government policies produces paths of asset prices that would appear, to an unwary researcher, to contain bubbles.

Suggested Citation

Flood, Robert P. and Hodrick, Robert J., Asset Price Volatility, Bubbles, and Process Switching (March 1986). NBER Working Paper No. w1867, Available at SSRN: https://ssrn.com/abstract=307107

Robert P. Flood (Contact Author)

International Monetary Fund (IMF) - Research Department ( email )

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Robert J. Hodrick

Columbia University - Columbia Business School, Finance ( email )

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