Avoiding the Pitfalls: Can Regime-Switching Tests Reliably Detect Bubbles?

Simon van Norden 1  and Robert Vigfusson 2
  • 1 Ecole des Hautes Etudes Commerciales, svn@alum.mit.edu
  • 2 Northwestern University, r-vigfusson@nwu.edu

Our paper uses simulation methods to examine the size and power of regime-switching tests for bubbles. We find that even with several hundred observations, the tests show sometimes considerable size distortion. This distortion makes the tests conservative; they understate the significance of the evidence of bubbles. Despite this, the tests display considerable power to detect bubbles even when using the conservative asymptotic critical values. We also find that the frequency with which bubbles collapse has an important influence on the tests' power. An application to monthly Canadian and American stock-price data provides mixed evidence of bubbles.

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SNDE recognizes that advances in statistics and dynamical systems theory can increase our understanding of economic and financial markets. The journal seeks both theoretical and applied papers that characterize and motivate nonlinear phenomena. Researchers are required to assist replication of empirical results by providing copies of data and programs online. Algorithms and rapid communications are also published.

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