Rational Bubbles in Stock Prices?

Behzad T. Diba, Herschel I. Grossman

NBER Working Paper No. 1779 (Also Reprint No. r1138)
Issued in October 1985
NBER Program(s):Monetary Economics, Economic Fluctuations and Growth

This paper reports empirical tests for the existence of rational bubbles in stock prices. The analysis focuses on a familiar model that defines market fundamentals to be the expected present value of dividends, discounted at a constantrate, and defines a rational bubble to be a self-confirming divergence of stock prices from market fundamentals in response to extraneous variables. The tests are based on the theoretical result that, if rational bubbles exist, time series obtained by differencing real stock prices do not have stationary means. Analysis of the data in both the time domain and the frequency domain suggests that the time series of aggregate real stock prices is nonstationary in levels but stationary in first differences. Applications of the time domain tests to simulated nonstationary time series that would be implied by rational bubbles indicates that the tests have power to detect relevant nonstationarity when it is present. Furthermore, application of the time-domain and frequency-domain tests to the time series of aggregate real dividends also indicates nonstationarity in levels but stationarity in first differences -- suggesting that market fundamentals can account for the stationarity properties of real stock prices. These findings imply that rational bubbles do not exist in stock prices. Accordingly,any evidence that stock price fluctuations do not accord with market fundamentals (asspecified above) is attributable to misspecification of market fundamentals.

download in pdf format
   (225 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w1779

Published: Diba and Grossman, "Explosive Rational Bubbles in Stock Prices?" from American Economic Review, Vol. 78, No. 3, June 1988, pp. 520-530.

Users who downloaded this paper also downloaded* these:
Diba and Grossman w1300 Rational Bubbles in the Price of Gold
Froot and Obstfeld w3091 Intrinsic Bubbles: The Case of Stock Prices
West w2067 A Specification Test for Speculative Bubbles
Diba and Grossman w1990 On the Inception of Rational Bubbles in Stock Prices
Diba and Grossman w2004 Rational Inflationary Bubbles
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us