Riding Bubbles

64 Pages Posted: 17 May 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 10, 2009

Abstract

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

Guenster, Nadja and Kole, Erik and Jacobsen, Ben, Riding Bubbles (December 10, 2009). ERIM Report Series Reference No. ERS-2009-058-F&A. Available at SSRN: https://ssrn.com/abstract=1606083

Nadja Guenster (Contact Author)

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

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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