Advertisement

Fundamental bubbles in equity markets

  • Florian IelpoEmail author
  • Mikita Kniahin
Focus
  • 4 Downloads

Abstract

Using an affine model to compute the price of equities based on a dataset of macroeconomic factors, we propose a measure of equity bubbles. We use a dynamic affine term structure framework to price equity and bonds jointly, and investigate how prices are related to a set of macrofactors extracted from a large dataset of economic time series. We analyze the discrepancies between market and model implied equity prices and use them as a measure for bubbles. A bubble is diagnosed over a given period whenever the discrepancies are not stationary and impact the underlying economy consistently with the literature’s findings, increasing over the shorter term economic activity before leading to a net loss in it. We perform the analysis over 3 major US and 3 major European equity indices over the 1990–2017 period and find bubbles only for two of the US equity indices, the S&P500 and the Dow Jones.

Keywords

Bubble Affine model Principal component analysis Data-rich Stationarity 

JEL Classification

G12 C58 E44 

Notes

Compliance with ethical standards

Conflict of interest

Florian Iepo declares that he has no conflict of interest. Mikita Knihain declares that he has no conflict of interest.

Ethical approval

This article does not contain any studies with human participants or animals performed by any of the authors.

Supplementary material

References

  1. Alessi L, Barigozzi M, Capasso M (2010) Improved penalization for determining the number of factors in approximate factor models. Stat Probab Lett 80(23):1806–1813MathSciNetzbMATHCrossRefGoogle Scholar
  2. Ang A, Liu J (2001) A general affine earnings valuation model. Rev Acc Stud 6(4):397–425CrossRefGoogle Scholar
  3. Ang A, Piazzesi M (2003) A no-arbitrage vector autoregression of term structure dynamics and macroeconomic and latent variables. J Monet Econ 50:745–787CrossRefGoogle Scholar
  4. Ang A, Piazzesi M, Wei M (2006) What does the yield curve tell us about gdp growth? J Econom 131(1):359–403MathSciNetzbMATHCrossRefGoogle Scholar
  5. Ang A, Ulrich M (2012) Nominal bonds, real bonds, and equity. In: Netspar discussion paper no. 12/2011-103Google Scholar
  6. Bansal R, Yaron A (2004) Risks for the long run: a potential resolution of asset pricing puzzles. J Finance 59(4):1481–1509CrossRefGoogle Scholar
  7. Bauer MD, Rudebusch GD (2016) Resolving the spanning puzzle in macro-finance term structure models. Rev Finance 21(2):511–553zbMATHCrossRefGoogle Scholar
  8. Beber A, Brandt MW, Luisi M (2015) Distilling the macroeconomic news flow. J Financ Econ 117(3):489–507CrossRefGoogle Scholar
  9. Bekaert G, Grenadier S (1999) Stock and bond pricing in an affine economy. NBER, CambridgeCrossRefGoogle Scholar
  10. Belo F, Collin-Dufresne P, Goldstein RS (2015) Dividend dynamics and the term structure of dividend strips. J Finance 70(3):1115–1160CrossRefGoogle Scholar
  11. Bernanke BS, Boivin J, Eliasz P (2005) Measuring the effects of monetary policy: a factor-augmented vector autoregressive (favar) approach. Q J Econ 120(1):387–422Google Scholar
  12. Brunnermeier MK (2010) Bubbles, liquidity, and the macroeconomy. NBER Report Online 01(2):10–12MathSciNetGoogle Scholar
  13. Brunnermeier MK, Oehmke M (2013) Bubbles, financial crises, and systemic risk. In: Handbook of the economics of finance, volume 2. Elsevier, pp 1221–1288Google Scholar
  14. Chen L, Da Z, Priestley R (2012) Dividend smoothing and predictability. Manag Sci 58(10):1834–1853CrossRefGoogle Scholar
  15. Cheridito P, Filipović D, Kimmel RL (2007) Market price of risk specifications for affine models: theory and evidence. J Financ Econ 83(1):123–170CrossRefGoogle Scholar
  16. Christensen JH, Diebold FX, Rudebusch GD (2011) The affine arbitrage-free class of Nelson–Siegel term structure models. J Econom 164(1):4–20MathSciNetzbMATHCrossRefGoogle Scholar
  17. Cochrane JH, Piazzesi M (2009) Decomposing the yield curve. In: Working paperGoogle Scholar
  18. Collin-Dufresne P, Goldstein RS, Jones CS (2008) Identification of maximal affine term structure models. J Finance 63(2):743–795CrossRefGoogle Scholar
  19. Constantinides GM (1992) A theory of the nominal term structure of interest rates. Rev Financ Stud 5(4):531–552CrossRefGoogle Scholar
  20. Dai Q, Singleton KJ (2000) Specification analysis of affine term structure models. J Finance 55(5):1943–1978CrossRefGoogle Scholar
  21. Dai Q, Singleton KJ (2002) Expectation puzzles, time-varying risk premia, and affine models of the term structure. J Financ Econ 63(3):415–441CrossRefGoogle Scholar
  22. Duffee GR (2002) Term premia and interest rate forecasts in affine models. J Finance 57(1):405–443CrossRefGoogle Scholar
  23. Duffie D (2004) Credit risk modeling with affine processes. Scuola Normale Superiore, PisazbMATHGoogle Scholar
  24. Duffie D, Filipović D, Schachermayer W (2003) Affine processes and applications in finance. Ann Appl Probab 13:984–1053MathSciNetzbMATHCrossRefGoogle Scholar
  25. Duffie D, Kan R (1996) A yield-factor model of interest rates. Math Finance 6(4):379–406zbMATHCrossRefGoogle Scholar
  26. Eraker B (2008) Affine general equilibrium models. Manag Sci 54(12):2068–2080zbMATHCrossRefGoogle Scholar
  27. Estrella A, Hardouvelis GA (1991) The term structure as a predictor of real economic activity. J Finance 46(2):555–576CrossRefGoogle Scholar
  28. Faust J, Rogers JH, Wright JH (2005) News and noise in G-7 GDP announcements. J Money Credit Bank 37(3):403–419CrossRefGoogle Scholar
  29. Fisher M, Gilles C (1998) Around and around: the expectations hypothesis. J Finance 53(1):365–383CrossRefGoogle Scholar
  30. Flannery MJ, Protopapadakis AA (2002) Macroeconomic factors do influence aggregate stock returns. Rev Financ Stud 15(3):751–782CrossRefGoogle Scholar
  31. Ghysels E, Horan C, Moench E (2014) Forecasting through the rear-view mirror: data revisions and bond return predictability. In: NY Fed Staff ReportsGoogle Scholar
  32. Grossman H, Diba B (1988) Explosive rational bubbles in stock prices? Am Econ Rev 78:520–30Google Scholar
  33. Gürkaynak RS (2008) Econometric tests of asset price bubbles: taking stock. J Econ Surv 22(1):166–186CrossRefGoogle Scholar
  34. Hall SG, Psaradakis Z, Sola M (1999) Detecting periodically collapsing bubbles: a Markov-switching unit root test. J Appl Econom 14:143–154CrossRefGoogle Scholar
  35. Hamilton JD (1994) Time series analysis, vol 2. Princeton University Press, PrincetonzbMATHGoogle Scholar
  36. Hamilton JD, Wu JC (2012) Identification and estimation of Gaussian affine term structure models. J Econom 168(2):315–331MathSciNetzbMATHCrossRefGoogle Scholar
  37. Harrison JM, Kreps DM (1979) Martingales and arbitrage in multiperiod securities markets. J Econ Theory 20(3):381–408MathSciNetzbMATHCrossRefGoogle Scholar
  38. Harvey CR (1988) The real term structure and consumption growth. J Financ Econ 22(2):305–333MathSciNetCrossRefGoogle Scholar
  39. Hirano T, Yanagawa N (2016) Asset bubbles, endogenous growth, and financial frictions. Rev Econ Stud 84(1):406–443MathSciNetCrossRefGoogle Scholar
  40. Hördahl P, Tristani O, Vestin D (2006) A joint econometric model of macroeconomic and term-structure dynamics. J Econom 131(1):405–444MathSciNetzbMATHCrossRefGoogle Scholar
  41. Jardet C, Monfort A, Pegoraro F (2013) No-arbitrage near-cointegrated VAR (p) term structure models, term premia and GDP growth. J Bank Finance 37(2):389–402CrossRefGoogle Scholar
  42. Joslin S, Priebsch M, Singleton KJ (2014) Risk premiums in dynamic term structure models with unspanned macro risks. J Finance 69(3):1197–1233CrossRefGoogle Scholar
  43. Joslin S, Singleton KJ, Zhu H (2011) A new perspective on Gaussian dynamic term structure models. Rev Financ Stud 24(3):926–970CrossRefGoogle Scholar
  44. Kim DH (2007) Challenges in macro-finance modeling. In: Working paperGoogle Scholar
  45. Kim DH, Wright JH (2005) An arbitrage-free three-factor term structure model and the recent behavior of long-term yields and distant-horizon forward rates. In: Working paperGoogle Scholar
  46. Leary MT, Michaely R (2011) Determinants of dividend smoothing: empirical evidence. Rev Financ Stud 24(10):3197–3249CrossRefGoogle Scholar
  47. Lemke W, Werner T (2009) The term structure of equity premia in an affine arbitrage-free model of bond and stock market dynamics. European Central Bank, FrankfurtGoogle Scholar
  48. LeRoy SF, Porter RD (1981) The present-value relation: tests based on implied variance bounds. Econometrica 49(3):555–574zbMATHCrossRefGoogle Scholar
  49. Lettau M, Wachter J (2011) The term structures of equity and interest rates. J Financ Econ 101:90–113CrossRefGoogle Scholar
  50. Martin A, Ventura J (2012) Economic growth with bubbles. Am Econ Rev 102(6):3033–3058CrossRefGoogle Scholar
  51. McCracken MW, Ng S (2016) FRED-MD: A monthly database for macroeconomic research. J Bus Econ Stat 34(4):574–589MathSciNetCrossRefGoogle Scholar
  52. Mönch E (2008) Forecasting the yield curve in a data-rich environment: a no-arbitrage factor-augmented VAR approach. J Econom 146(1):26–43MathSciNetzbMATHCrossRefGoogle Scholar
  53. Monfort A, Pegoraro F (2007) Switching varma term structure models-extended version. In: Working paperGoogle Scholar
  54. Phillips PC, Shi S, Yu J (2015) Testing for multiple bubbles: historical episodes of exuberance and collapse in the S&P 500. Int Econ Rev 56(4):1043–1078zbMATHCrossRefGoogle Scholar
  55. Piazzesi M (2010) Affine term structure models. Handb Financ Econom 1:691–766CrossRefGoogle Scholar
  56. Rudebusch GD, Wu T (2008) A macro-finance model of the term structure, monetary policy and the economy. Econ J 118(530):906–926CrossRefGoogle Scholar
  57. Shiller R (1981) Do stock prices move too much to be justified by subsequent changes in dividends? Am Econ Rev 71:421–436Google Scholar
  58. Simon DP (2003) The Nasdaq volatility index during and after the bubble. J Deriv 11(2):9–24CrossRefGoogle Scholar
  59. Sornette D, Woodard R, Zhou W-X (2009) The 2006–2008 oil bubble: evidence of speculation, and prediction. Physica A 388(8):1571–1576CrossRefGoogle Scholar
  60. Stock JH, Watson MW (1998) Diffusion indexes. Technical report, National Bureau of Economic ResearchGoogle Scholar
  61. Swanson E (2014) A macroeconomic model of equities and real, nominal, and defaultable debt. Unpublished Manuscript, University of California, IrvineGoogle Scholar
  62. Trapani L (2017) A randomised sequential procedure to determine the number of factors. J Am Stat Assoc 113:1341–1349zbMATHCrossRefGoogle Scholar
  63. Van Binsbergen J, Brandt M, Koijen R (2012) On the timing and pricing of dividends. Am Econ Rev 102(4):1596–1618CrossRefGoogle Scholar
  64. Van Binsbergen JH, Koijen RS (2017) The term structure of returns: facts and theory. J Financ Econ 124(1):1–21CrossRefGoogle Scholar
  65. West KD (1988) Bubbles, fads and stock price volatility tests: a partial evaluation. J Finance 43(3):639–656CrossRefGoogle Scholar
  66. Wu T (2001) Macro factors and the affine term structure of interest rates. In: Working paperGoogle Scholar

Copyright information

© Springer-Verlag GmbH Germany, part of Springer Nature 2019

Authors and Affiliations

  1. 1.UnigestionGenevaSwitzerland
  2. 2.Centre d’Economie de la SorbonneParisFrance

Personalised recommendations