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EXPLOSIVE BEHAVIOR IN THE 1990s NASDAQ: WHEN DID EXUBERANCE ESCALATE ASSET VALUES?

Authors

  • Peter C. B. Phillips,

    1. Yale University, University of Auckland, University of Southampton, and Singapore Management University; Rutgers University and Central University of Finance and Economics (Chinese Academy of Finance and Development); Singapore Management University
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  • Yangru Wu,

    1. Yale University, University of Auckland, University of Southampton, and Singapore Management University; Rutgers University and Central University of Finance and Economics (Chinese Academy of Finance and Development); Singapore Management University
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  • Jun Yu

    1. Yale University, University of Auckland, University of Southampton, and Singapore Management University; Rutgers University and Central University of Finance and Economics (Chinese Academy of Finance and Development); Singapore Management University
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    • The authors thank the co-editor, three anonymous referees, Yacine Aït-Sahalia, Geert Bekaert, Prasad Bidarkota, Markus Brunnermeier, Robert Flood, George Furstenberg, Peter Garber, Hans Genberg, Adrian Pagan, Lubos Pastor, Michael Robert, Dragon Tang, Pietro Veronesi, Matthew Yiu, and conference/seminar participants at Econometric Society Winter Meetings, Financial Management Association Meeting, the Fundamental and Nonfundamental Asset Pricing Dynamics Conference in Norway, Hong Kong Institute for Monetary Research (HKIMR), Financial Engineering and Risk Management 2007 Meeting, International Symposium for Econometric Theory and Application 2009 Meeting, National University of Singapore, Central University of Finance and Economics (CUFE), Rutgers, and University of Toronto for comments. All errors remain our responsibility. Phillips gratefully acknowledges partial support from a Kelly Fellowship and the NSF under Grant Nos. SES 04-142254 and SES 06- 47086. Yu gratefully acknowledges financial support from the Singapore Ministry of Education AcRF Tier 2 fund under Grant No. T206B4301-RS. Part of this work was completed while Wu visited HKIMR and CUFE. He thanks these institutions for their warm hospitalities. He thanks a faculty research grant from Rutgers Business School and the Whitcomb Financial Services Center for partial financial support. Please address correspondence to: Jun Yu, School of Economics and Sim Kee Boon Institute for Financial Economics, Singapore Management University, Singapore 178903, Singapore. E-mail: yujun@smu.edu.sg.


  • Manuscript received July 2008; revised August 2009.

Abstract

A recursive test procedure is suggested that provides a mechanism for testing explosive behavior, date stamping the origination and collapse of economic exuberance, and providing valid confidence intervals for explosive growth rates. The method involves the recursive implementation of a right-side unit root test and a sup test, both of which are easy to use in practical applications, and some new limit theory for mildly explosive processes. The test procedure is shown to have discriminatory power in detecting periodically collapsing bubbles, thereby overcoming a weakness in earlier applications of unit root tests for economic bubbles. An empirical application to the Nasdaq stock price index in the 1990s provides confirmation of explosiveness and date stamps the origination of financial exuberance to mid-1995, prior to the famous remark in December 1996 by Alan Greenspan about irrational exuberance in the financial market, thereby giving the remark empirical content.

How do we know when irrational exuberance has unduly escalated asset values? (Alan Greenspan, 1996)

Experience can be a powerful teacher. The rise and fall of internet stocks, which created and then destroyed $8 trillion of shareholder wealth, has led a new generation of economists to acknowledge that bubbles can occur. (Alan Krueger, 2005)

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