Explosive Behavior in the 1990s Nasdaq: When Did Exuberance Escalate Asset Values?

HKIMR Working Paper No. 22/2007

40 Pages Posted: 12 Feb 2008

See all articles by Peter C. B. Phillips

Peter C. B. Phillips

Yale University - Cowles Foundation; University of Auckland; University of Southampton; Singapore Management University - School of Economics

Yangru Wu

Rutgers University, Newark - School of Business - Department of Finance & Economics

Jun Yu

Singapore Management University; Singapore Management University - Lee Kong Chian School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: November 2007

Abstract

A recursive test procedure is suggested that provides a mechanism for testing explosive behavior, date-stamping the origination and collapse of economic exuberance, and providing valid confidence intervals for explosive growth rates. The method involves the recursive implementation of a right-side unit root test and a sup test, both of which are easy to use in practical applications, and some new limit theory for mildly explosive processes. The test procedure is shown to have discriminatory power in detecting periodically collapsing bubbles, thereby overcoming a weakness in earlier applications of unit root tests for economic bubbles. Some asymptotic properties of the Evans (1991) model of periodically collapsing bubbles are analyzed and the paper develops a new model in which bubble duration depends on the strength of the cognitive bias underlying herd behavior in the market. The paper also explores alternative propagating mechanisms for explosive behavior based on economic fundamentals under time varying discount rates. An empirical application to the Nasdaq stock price index in the 1990s provides confirmation of explosiveness and date-stamps the origination of financial exuberance to June 1995, prior to the famous remark in December 1996 by Alan Greenspan about irrational exuberance in financial markets, thereby giving the remark empirical content.

Keywords: Explosive root, irrational exuberance, mildly explosive process, Nasdaq bubble, periodically collapsing bubble, sup test, time-varying discount rate, unit root test

JEL Classification: G10, C22

Suggested Citation

Phillips, Peter C. B. and Wu, Yangru and Yu, Jun, Explosive Behavior in the 1990s Nasdaq: When Did Exuberance Escalate Asset Values? (November 2007). HKIMR Working Paper No. 22/2007, Available at SSRN: https://ssrn.com/abstract=1091830 or http://dx.doi.org/10.2139/ssrn.1091830

Peter C. B. Phillips

Yale University - Cowles Foundation ( email )

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University of Auckland ( email )

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University of Southampton

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Singapore Management University - School of Economics

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Yangru Wu

Rutgers University, Newark - School of Business - Department of Finance & Economics ( email )

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HOME PAGE: http://andromeda.rutgers.edu/~yangruwu

Jun Yu

Singapore Management University ( email )

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HOME PAGE: http://www.mysmu.edu/faculty/yujun/

Singapore Management University - Lee Kong Chian School of Business ( email )

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