Date of Award

2016

Document Type

Honors Thesis (Open Access)

Department

Colby College. Economics Dept.

Advisor(s)

Michael Donihue

Second Advisor

Leonard Wolk

Abstract

To this day, economists argue about the existence of stock market bubbles. The literature review for this paper observes the analysis of four reputable bubble tests in an attempt to provide ample qualitative proof for the existence of bubbles. The first obstacle for creating an effective bubble detection test is the difficulty of estimating true fundamental values for equities. Without adequate estimations for the fundamental values of equities, the deviation between actual price and fundamental price is impossible to observe or estimate. Additionally, these tests are reliant on strong underlying assumptions, which tend to cloud results.

This thesis applies a price-to-earnings ratio test adapted from a thesis written by Bram Weites and Malte von Maravic (2010). The model utilizes a relationship between the risk and price-to-earnings ratios of equities to econometrically test for bubbles. The test has an advantage over previous bubble literature because it does not require the estimation of the fundamental values of equities. A rolling regression is applied to the econometric model, and four bubbles are detected. The Dot-com bubble is detected with complete confidence, and three other bubbles are detected with slightly less confidence.

Keywords

Stock Market, Equity, Bubble, Price-to-Earnings Ratio, Econometrics

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