Testing for Rational Bubbles in a Co-Explosive Vector Autoregression

Shorter and revised version published in: Econometrics Journal, Vol. 15, Nr. 2, 2012, s. 226-254.

54 Pages Posted: 26 Jun 2010 Last revised: 28 Feb 2013

See all articles by Tom Engsted

Tom Engsted

University of Aarhus - CREATES

Bent Nielsen

University of Oxford - Department of Economics

Date Written: June 24, 2010

Abstract

We derive the parameter restrictions that a standard equity market model implies for a bivariate vector autoregression for stock prices and dividends, and we show how to test these restrictions using likelihood ratio tests. The restrictions, which imply that stock returns are unpredictable, are derived both for a model without bubbles and for a model with a rational bubble. In both cases we show how the restrictions can be tested through standard chi-squared inference. The analysis for the no-bubble case is done within the traditional Johansen model for I(1) variables, while the bubble model is analysed using a co-explosive framework. The methodology is illustrated using US stock prices and dividends for the period 1872-2000.

Keywords: Rational bubbles, Explosiveness and co-explosiveness, Cointegration, Vector autoregression, Likelihood ratio tests

JEL Classification: C12, C32, G12

Suggested Citation

Engsted, Tom and Nielsen, Bent, Testing for Rational Bubbles in a Co-Explosive Vector Autoregression (June 24, 2010). Shorter and revised version published in: Econometrics Journal, Vol. 15, Nr. 2, 2012, s. 226-254.. Available at SSRN: https://ssrn.com/abstract=1630251 or http://dx.doi.org/10.2139/ssrn.1630251

Tom Engsted (Contact Author)

University of Aarhus - CREATES ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Bent Nielsen

University of Oxford - Department of Economics ( email )

Manor Road Building
Manor Road
Oxford, OX1 3BJ
United Kingdom

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