Some Econometric Results for the Blanchard-Watson Bubble Model

10 Pages Posted: 18 May 2011 Last revised: 18 Jun 2011

See all articles by Soren Johansen

Soren Johansen

University of Copenhagen - Department of Economics; Aarhus University - CREATES

Theis lange

affiliation not provided to SSRN

Date Written: May 9, 2011

Abstract

The purpose of the present paper is to analyse a simple bubble model suggested by Blanchard and Watson. The model is defined by y(t) =s(t)ρy(t-1) ε(t), t=1,…,n, where s(t) is an i.i.d. binary variable with p=P(s(t)=1), independent of ε(t) i.i.d. with mean zero and finite variance. We take ρ>1 so the process is explosive for a period and collapses when s(t)=0. We apply the drift criterion for non-linear time series to show that the process is geometrically ergodic when p<1, because of the recurrent collapse. It has a finite mean if pρ<1, and a finite variance if pρ²<1. The question we discuss is whether a bubble model with infinite variance can create the long swings, or persistence, which are observed in many macro variables. We say that a variable is persistent if its autoregressive coefficient ρ(n) of y(t) on y(t-1), is close to one. We show that the estimator of ρ(n) converges to ρp, if the variance is finite, but if the variance of y(t) is infinite, we prove the curious result that the estimator converges to ρ⁻¹. The proof applies the notion of a tail index of sums of positive random variables with infinite variance to find the order of magnitude of the product moments of y(t).

Keywords: time series, explosive processes, bubble models

JEL Classification: C32

Suggested Citation

Johansen, Soren and lange, Theis, Some Econometric Results for the Blanchard-Watson Bubble Model (May 9, 2011). University of Copenhagen, Department of Economics, Discussion Paper No. 11-15, Available at SSRN: https://ssrn.com/abstract=1837262 or http://dx.doi.org/10.2139/ssrn.1837262

Soren Johansen (Contact Author)

University of Copenhagen - Department of Economics ( email )

Øster Farimagsgade 5
Bygning 26
1353 Copenhagen K.
Denmark

Aarhus University - CREATES ( email )

Nordre Ringgade 1
Aarhus, DK-8000
Denmark

Theis Lange

affiliation not provided to SSRN ( email )

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