Speculative Behaviour, Regime-Switching and Stock Market Crashes

Bank of Canada Working Paper 96-13

60 Pages Posted: 11 Feb 1998

See all articles by Simon van Norden

Simon van Norden

HEC Montreal - Department of Finance; CIRANO; University of Montreal - Center for Interuniversity Research in Econometrics

Huntley Schaller

Carleton University - Department of Economics

Date Written: October 1996

Abstract

This paper uses regime-switching econometrics to study stock market crashes and to explore the ability of two very different economic explanations to account for historical crashes. The first explanation is based on historical accounts of "manias and panics." Its key features are that "overvaluation" increases the probability and expected size of a crash. Using U.S. data for 1926-89, we find considerable support for this model's predictions. The second explanation is based on switches in fundamentals. Simulations show that switching fundamentals can cause markets to mimic speculative behaviour. However, switches in fundamentals do not coincide with most stock market crashes.

JEL Classification: E44

Suggested Citation

van Norden, Simon and Schaller, Huntley, Speculative Behaviour, Regime-Switching and Stock Market Crashes (October 1996). Bank of Canada Working Paper 96-13, Available at SSRN: https://ssrn.com/abstract=58691 or http://dx.doi.org/10.2139/ssrn.58691

Simon Van Norden

HEC Montreal - Department of Finance ( email )

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Huntley Schaller (Contact Author)

Carleton University - Department of Economics ( email )

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