Bubbles, Rational Expectations and Financial Markets

30 Pages Posted: 27 Apr 2000 Last revised: 3 Aug 2010

See all articles by Olivier J. Blanchard

Olivier J. Blanchard

National Bureau of Economic Research (NBER); Peter G. Peterson Institute for International Economics

Mark W. Watson

Princeton University - Woodrow Wilson School of Public and International Affairs; National Bureau of Economic Research (NBER)

Date Written: July 1982

Abstract

This paper investigates the nature and the presence of bubbles in financial markets. Are bubbles consistent with rationality? If they are, do they, like Ponzi games, require the presence of new players forever? Do they imply impossible events in finite time, such as negative prices? Do they need to go on forever to be rational? Can they have real effects? These are some of the questions asked in the first three sections. The general conclusion is that bubbles, in many markets, are consistent with rationality, that phenomena such as runaway asset prices and market crashes are consistent with rational bubbles. In the last two sections, we consider whether the presence of bubbles in a particular market can be detected statistically. The task is much easier if there are data on both prices and returns. In this case, as shown by Shiller and Singleton, the hypothesis of no bubble implies restrictions on their joint distribution and can be tested. In markets in which returns are difficult to observe, possibly because of a nonpecuniary component, such as gold, the task is more difficult. We consider the use of both "runs tests" and "tail tests" and conclude that they give circumstantial evidence at best.

Suggested Citation

Blanchard, Olivier J. and Watson, Mark W., Bubbles, Rational Expectations and Financial Markets (July 1982). NBER Working Paper No. w0945. Available at SSRN: https://ssrn.com/abstract=226909

Olivier J. Blanchard (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Peter G. Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

Mark W. Watson

Princeton University - Woodrow Wilson School of Public and International Affairs ( email )

Princeton University
Princeton, NJ 08544-1021
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
853
Abstract Views
9,490
rank
27,225
PlumX Metrics