Speculative Components in Mature Stock Markets: Do They Exist and are They Related?

Abstract

Economists have long conjectured that movements in stock prices may involve speculative components. This bubble, as it is usually referred to, is defined as the difference between the market value of a security and its fundamental value. Although there are several important theoretical issues surrounding the topic of asset bubbles, their existence is inherently an empirical issue that has not been settled. This paper proposes a new methodology for testing for the existence of rational bubbles. Unlike previous authors, we treat both the dividend and the bubble process as part of the state vector. The new methodology is applied to the four mature markets of the U.S., Japan, England and Germany to test whether a bubble was present during the period of January 1951 to December 1998. This paper also examines whether there are linkages between these national bubbles. We find evidence that U.S. bubbles cause bubbles in the other three markets but we find no evidence for reverse causality.

Keywords: Speculative, components, mature, stock, markets