Are There Rational Bubbles in the US Stock Market? Overview and a New Test

Abstract

A speculative bubble is usually 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, the existence of bubbles is inherently an empirical issue that has not been settled yet. This paper reviews several important tests and offers one more methodology that improves upon the existing ones. The new test is applied to the annual US stock market data spanning over a century and at the monthly frequency covering the post-war period. Although we find evidence of stock price bubble in both cases, the post-war period exhibit only positive component whereas the annual data exhibit some episode of negative bubble.

Keywords: Stock Market, Asset Bubbles, Testing for Market Overvaluation, Fundamental Valuation

JEL Classification: C1, C4, G1, E2