Testing for Explosive Bubbles in the Presence of Autocorrelated Innovations
40 Pages Posted: 14 Feb 2017 Last revised: 28 Sep 2017
Date Written: September 27, 2017
We analyze an empirically important issue with recursive right-tailed unit root tests for bubbles in asset prices. First, we show that serially correlated innovations, which is a feature that is present in most financial series used to test for bubbles, can lead to severe size distortions when using either fixed or automatic (based on information criteria) lag-length selection in the auxiliary regressions underlying the test. Second, we propose a sieve-bootstrap version of these tests and show that this results in more or less perfectly sized test statistics even in the presence of highly autocorrelated innovations. We also find that these improvements in size come at a relatively low cost for the power of the tests. Finally, we apply the bootstrap tests on the housing market of OECD countries, and generally find less strong evidence of bubbles compared to existing evidence.
Keywords: Right-tailed unit root tests, GSADF, size and power properties, sieve bootstrap, international housing market
JEL Classification: C58, G12
Suggested Citation: Suggested Citation