An Evaluation of Recent Evidence on Stock Market Bubbles

Abstract

Several recent studies have attributed a large part of asset price volatility to self-fulfilling expectations. Such an explanation is unattractive to many since it allows allocations that need bear no particular relation to those implied by the economist's standard kit ofmarket fundamentals. We examine the evidence presented in some of thesestudies and find (i) that all of the bubble evidence can equally well beinterpreted as evidence of model misspecification and (ii) that a slight extension of standard econometric methods points very strongly toward model misspecification as the actual reason for the failure of simple models of market fundamentals to explain asset price volatility.