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Forecasting the Collapse of Speculative Bubbles: An Empirical Investigation of the S&P 500 Composite Index

Author

Listed:
  • Chris Brooks

    (ICMA Centre, University of Reading)

  • Apostolos Katsaris

    (ICMA Centre, University of Reading)

Abstract

In this paper we test for the presence of periodically partially collapsing, positive and negative, speculative bubbles in the S&P 500 Composite Index for the period 1888-2001. We extend existing regime-switching models of speculative behaviour by including abnormal volume as an indicator of the probable time of the bubble collapse. Abnormal volume is included as both a classifying variable that helps predict the probability of the bubble surviving, and as a factor of risk in the surviving state equation. Increased volume is considered a signal that market beliefs concerning the future of the bubble are changing. We show that abnormal volume is a significant predictor and classifier of returns. Furthermore, we examine the financial usefulness of the augmented model by studying the risk-adjusted profits of a trading rule formed using inferences from it. Use of the augmented model trading rule leads to higher risk adjusted returns than those obtained from employing existing models or a buy and hold strategy.

Suggested Citation

  • Chris Brooks & Apostolos Katsaris, 2002. "Forecasting the Collapse of Speculative Bubbles: An Empirical Investigation of the S&P 500 Composite Index," ICMA Centre Discussion Papers in Finance icma-dp2002-04, Henley Business School, University of Reading.
    • Handle: RePEc:rdg:icmadp:icma-dp2002-04
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    File URL: http://www.icmacentre.ac.uk/pdf/discussion/DP2002-04.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Stock market bubbles; fundamental values; dividends; regime switching; speculative bubble tests;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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