Bubbles: Ride, Watch or Play the Pop?
May 20, 2010 - Fundamental Valuation
Should investors go with or against asset pricing bubbles? Or, should they step aside and await a “Return to Normalcy?” In their December 2009 paper entitled “Riding Bubbles”, Nadja Guenster, Erik Kole and Ben Jacobsen investigate empirically the best approach for investors to take regarding active asset bubbles. They detect bubbles within rolling historical 10-year intervals based on two criteria: (1) price advances faster than growth rates of fundamental value based on three widely used asset pricing models; and, (2) sudden accelerations in price unexplained by these models. More descriptively, a bubble is a structural break followed by abnormally positive returns, and ended with a crash. Using monthly returns and contemporaneous fundamentals for 48 value-weighted industry indexes spanning July 1926 to December 2006, they conclude that: Keep Reading