On the Predictability of Stock Market Bubbles: Evidence from LPPLS ConfidenceTM Multi-Scale Indicators

Quantitative Finance, Forthcoming.

18 Pages Posted: 28 Nov 2017 Last revised: 23 Sep 2018

See all articles by Riza Demirer

Riza Demirer

Southern Illinois University Edwardsville - Department of Economics & Finance; Economic Research Forum (ERF)

Guilherme Demos

ETH Zürich

Rangan Gupta

University of Pretoria - Department of Economics

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss Finance Institute

Date Written: July 1, 2017

Abstract

We examine the predictive power of market-based indicators over the positive and negative stock market bubbles via an application of the LPPLS Confidence TM Multi-scale Indicators to the S&P 500 index. We find that the LPPLS framework is able to successfully capture, ex-ante, some of the prominent bubbles across different time scales, such as the Black Monday, Dot-com, and Subprime Crisis periods. We then show that measures of short selling activity have robust predictive power over negative bubbles across both short and long time horizons, in line with the previous studies suggesting that short sellers have predictive ability over stock price crash risks. Market liquidity, on the other hand, is found to have robust predictive power over both the negative and positive bubbles, while its predictive power is largely limited to short horizons. Short selling and liquidity are thus identified as two important factors contributing to the LPPLS-based bubble indicators. The evidence overall points to the predictability of stock market bubbles using market-based proxies of trading activity and can be used as a guideline to model and monitor the occurrence of bubble conditions in financial markets.

Keywords: Financial bubble indicators, LPPL method, Markov switching, Predictability, Short interest

JEL Classification: C13, C58, G14

Suggested Citation

Demirer, Riza and Demos, Guilherme and Gupta, Rangan and Sornette, Didier, On the Predictability of Stock Market Bubbles: Evidence from LPPLS ConfidenceTM Multi-Scale Indicators (July 1, 2017). Quantitative Finance, Forthcoming., Available at SSRN: https://ssrn.com/abstract=3076609 or http://dx.doi.org/10.2139/ssrn.3076609

Riza Demirer (Contact Author)

Southern Illinois University Edwardsville - Department of Economics & Finance ( email )

Department of Economics & Finance
Alumni Hall 3144
Edwardsville, IL 62026-1102
United States
(618) 650-2939 (Phone)
(618) 650-3047 (Fax)

HOME PAGE: http://www.siue.edu/~rdemire/

Economic Research Forum (ERF)

21 Al-Sad Al-Aaly St.
(P.O. Box: 12311)
Cairo, Cairo
Egypt

HOME PAGE: http://erf.org.eg/affiliates/riza-demirer-3/

Guilherme Demos

ETH Zürich ( email )

Rämistrasse 101
ZUE F7
Zürich, 8092
Switzerland

Rangan Gupta

University of Pretoria - Department of Economics ( email )

Lynnwood Road
Hillcrest
Pretoria, 0002
South Africa

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

Scheuchzerstrasse 7
Zurich, ZURICH CH-8092
Switzerland
41446328917 (Phone)
41446321914 (Fax)

HOME PAGE: http://www.er.ethz.ch/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
383
Abstract Views
1,452
rank
84,344
PlumX Metrics