Riding Bubbles

80 Pages Posted: 17 Mar 2008 Last revised: 18 Mar 2010

See all articles by Nadja Guenster

Nadja Guenster

University of Muenster - Finance Center Muenster; University of California, Berkeley

Erik Kole

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute; ERIM; Tinbergen Institute

Ben Jacobsen

Tilburg University - TIAS School for Business and Society; Massey University

Multiple version iconThere are 2 versions of this paper

Date Written: December 9, 2009

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 Classification: G10, G14, C14

Suggested Citation

Guenster, Nadja and Kole, Erik and Jacobsen, Ben, Riding Bubbles (December 9, 2009). Paris December 2007 Finance International Meeting AFFI-EUROFIDAI Paper. Available at SSRN: https://ssrn.com/abstract=1071670 or http://dx.doi.org/10.2139/ssrn.1071670

Nadja Guenster

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany

University of California, Berkeley ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

Erik Kole (Contact Author)

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 12 58 (Phone)

HOME PAGE: http://people.few.eur.nl/kole

ERIM

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

HOME PAGE: http://people.few.eur.nl/kole

Ben Jacobsen

Tilburg University - TIAS School for Business and Society ( email )

Warandelaan 2
TIAS Building
Tilburg, Noord Brabant 5037 AB
Netherlands

Massey University ( email )

Auckland
New Zealand

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