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Signaling Asset Price Bubbles with Time-Series Methods

50 Pages Posted: 11 Feb 2012  

Katja Taipalus

Bank of Finland - Financial Stability and Statistics

Date Written: February 2, 2012

Abstract

This paper provides an early warning indicator for bubbles in financial markets. The indicator is based on traditional unit root tests, more precisely on the augmented Dickey-Fuller test and may be used in a repeated manner with rolling samples. The performance of the indicator is tested extensively via Monte Carlo simulations and comparisons of the results with the most powerful standard (stability) tests. The new indicator seems to be more robust and to have more power than the standard tests. In empirical application to US stock market data for 1871–2010, the new indicator signals most of the consensus bubbles and gives warning signals well ahead of the crash, in most cases as early as 12 months ahead. The indicator also signals most of the 'negative bubbles' before their turning points.

Keywords: asset prices, financial crises, bubbles, indicator, unit-root

JEL Classification: G12, C15, G01

Suggested Citation

Taipalus, Katja, Signaling Asset Price Bubbles with Time-Series Methods (February 2, 2012). Bank of Finland Research Discussion Paper No. 7/2012. Available at SSRN: https://ssrn.com/abstract=1998236 or http://dx.doi.org/10.2139/ssrn.1998236

Katja Taipalus (Contact Author)

Bank of Finland - Financial Stability and Statistics ( email )

Finland

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