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

Abstract

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

Pedersen, Thomas Quistgaard and Schütte, Erik Christian Montes, Testing for Explosive Bubbles in the Presence of Autocorrelated Innovations (September 27, 2017). Available at SSRN: https://ssrn.com/abstract=2916616 or http://dx.doi.org/10.2139/ssrn.2916616

Thomas Quistgaard Pedersen (Contact Author)

Aarhus University - CREATES ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Erik Christian Montes Schütte

Aarhus University - CREATES ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

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