64 Pages Posted: 17 May 2010
Date Written: December 10, 2009
Bubbles can persist because investors are better off riding bubbles. We deﬁne bubbles in a natural way as significant, prolonged deviations from fundamental values measured by the well-known asset pricing models. Our real-time bubble detection system shows that –using US industry returns– periods of both higher volatility and higher abnormal returns follow noisy positive bubble signals. However, for the typical investor the risk-return trade-off improves. Riding bubbles generates annual abnormal returns of three to nine percent. These conclusions are robust to different assumptions and our system allows for alternative multifactor models as proxies for fundamental value.
Keywords: market efficiency, structural breaks, bubbles, asset pricing model, limits to arbitrage
JEL Classification: G14, C14, G10
Suggested Citation: Suggested Citation