An Evaluation of Recent Evidence on Stock Market Bubbles

Robert P. Flood, Robert J. Hodrick, Paul Kaplan

NBER Working Paper No. 1971
Issued in July 1986
NBER Program(s):   ME

Several recent studies have attributed a large part of asset price volatility to self-fulfilling expectations. Such an explanation is unattractive to many since it allows allocations that need bear no particular relation to those implied by the economist's standard kit of

market fundamentals. We examine the evidence presented in some of these

studies and find (i) that all of the bubble evidence can equally well be

interpreted as evidence of model misspecification and (ii) that a slight extension of standard econometric methods points very strongly toward model misspecification as the actual reason for the failure of simple models of market fundamentals to explain asset price volatility.

(318 K)

Published: Robert P. Flood and Peter M. Garber, eds., Speculative Bubbles, Speculative Attacks and Policy Switching, M.I.T. Press, 1994, pp. 105-133.

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