Testable Implications of Indeterminacies in Models with Rational Expectations, Issue 2903
National Bureau of Economic Research, 1989 - Foreign exchange rates - 31 pages
The possibility that movements in market prices of assets or goods may be caused by self-fulfilling prophecies, called bubbles or sunspots, has long intrigued market observers. If bubbles or sunspots exist, market prices differ from their fundamental values, and markets do not necessarily allocate resources to their best possible uses. Some might argue then that public policies would be needed to alleviate such problems. This paper surveys the current state of the empirically-oriented literature concerning rational dynamic indeterminacies by which we mean a situation of self-fulfilling prophecy within a rational expectations model. The empirical work in this area concentrates primarily on indeterminacies in price levels, exchange rates and equity prices. We first examine a particular type of explosive indeterminacy, usually called a rational bubble, in a familiar model of equity pricing. We then consider empirical work relating to price level and exchange rate indeterminacies, before examining empirical studies of indeterminacies in stock prices. Finally, we take up some interpretive issues. We find that existing bubbles tests do not establish that rational bubbles exist in asset prices.
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agents asset prices bt+1 bubble process bubble tests bubbles hypothesis bubbles or sunspots Campbell and Shiller coefficients constant expected rate constant expected return constructed discounted dividend forecasting equation dividend process equilibrium equity prices Eugene Fama ex post rational exchange rate exist in asset expected return model explosive indeterminacies Flood and Garber Flood and Peter foreign exchange markets fundamentals price future dividends Gregory Mankiw Hodrick IMPLICATIONS OF INDETERMINACIES INDETERMINACIES IN MODELS information set Kenneth Rogoff literature logarithm Mark Watson market fundamentals market price misspecification MODELS WITH RATIONAL money demand money supply null hypothesis Number Olivier Blanchard post rational price present value price level price path probability of monetary rational bubbles rational expectations model reduced form regressor Richard Meese Robert Flood Robert Shiller sample self-fulfilling prophecies solution to equation specification test standard error stock prices test for bubbles TESTABLE IMPLICATIONS transversality condition U.S. dollar variable variance bound inequality volatility tests