Bubbles and Crashes: Empirical Evidence

Posted: 6 Mar 2006

See all articles by Erik Kole

Erik Kole

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute; ERIM; Tinbergen Institute

Nadja Guenster

University of Muenster - Finance Center Muenster; University of California, Berkeley

Ben Jacobsen

Tilburg University - TIAS School for Business and Society; Massey University

Date Written: March 1, 2006

Abstract

Stock market crashes are rare events. This complicates a thorough quantitative empirical analysis of crashes and their probable causes. We introduce the concept of an industry crash and study the presence of these crashes in 48 US industry indexes over the period 1926 to 2004. The concept of an industry crash enlarges the sample of crashes available for study substantially. This large sample of crashes allows us to test several theoretical hypotheses recently put forward in the literature on the relation between bubbles and crashes. Our empirical evidence shows that bubbles - periods of strong outperformance - double the likelihood of a crash. This relation is stronger for more severe crashes: for the twenty percent largest industry crashes the presence of a bubble triples the crash probability. Our results also confirm theoretical results that crashes are more likely when bubble growth is stronger, but that the time a bubble takes to develop seems unrelated to crash likelihood. Last but not least, we verify whether these results for industry crashes carry over to general stock market crashes using shorter time series of stock market indexes for 49 countries starting in 1969. We find that they do.

Keywords: bubbles, crashes, skewness

JEL Classification: G10, G14, C14

Suggested Citation

Kole, Erik and Guenster, Nadja and Jacobsen, Ben, Bubbles and Crashes: Empirical Evidence (March 1, 2006). Available at SSRN: https://ssrn.com/abstract=887689

Erik Kole (Contact Author)

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 12 58 (Phone)

HOME PAGE: http://people.few.eur.nl/kole

ERIM

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

HOME PAGE: http://people.few.eur.nl/kole

Nadja Guenster

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany

University of California, Berkeley ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

Ben Jacobsen

Tilburg University - TIAS School for Business and Society ( email )

Warandelaan 2
TIAS Building
Tilburg, Noord Brabant 5037 AB
Netherlands

Massey University ( email )

Auckland
New Zealand

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