You are not currently logged in.

Access your personal account or get JSTOR access through your library or other institution:


Log in to your personal account or through your institution.

Trading Rules from Forecasting the Collapse of Speculative Bubbles for the S&P 500 Composite Index

Chris Brooks and Apostolos Katsaris
The Journal of Business
Vol. 78, No. 5 (September 2005), pp. 2003-2036
DOI: 10.1086/431450
Stable URL:
Page Count: 34
  • Download PDF
  • Add to My Lists
  • Cite this Item
Trading Rules from Forecasting the Collapse of Speculative Bubbles for the S&P; 500 Composite Index
We're having trouble loading this content. Download PDF instead.


Many recent studies documented the presence of speculative bubbles, defined as systematic and increasing deviations of actual prices from fundamentals, in asset prices. However, thus far, the usefulness of such models has been examined in the literature only from a statistical perspective. In this paper, we employ two‐regime switching models of periodically partially collapsing speculative bubbles and examine the risk‐adjusted profits of trading rules formed using inferences from them. Use of trading rules derived from an augmented model incorporating market volume leads to higher risk‐adjusted returns than those obtained employing existing models or a buy‐and‐hold strategy.

Notes and References

This item contains 28 references.

  • ['Billio, Monica, and Loriana Pelizzon. 2000. Value at risk: A multivariate regime switching approach. Journal of Empirical Finance 7 (December):531–54.']
  • ['Blanchard, Oliver J., and Mark W. Watson. 1982. Bubbles, rational expectations and financial markets. Working Paper no. 945. National Bureau of Economic Research, Cambridge, MA.']
  • ['Brooks, Chris, and Apostolos Katsaris. 2002. Regime switching models of speculative bubbles with volume: An empirical investigation of the S&P500 Composite Index. Unpublished manuscript, ISMA Centre, University of Reading.']
  • ['———. 2005. A three‐regime model of speculative behaviour: Modelling the evolution of bubbles in the S&P 500 Composite Index. Economic Journal 115, 763–93.']
  • ['Campbell, John Y., and Robert Shiller. 1987. Cointegration and tests of present value models. Journal of Political Economy 95 (October):1062–88.']
  • ['Cutler, David M., James M. Poterba, and Lawrence H. Summers. 1991. Speculative dynamics. Review of Economic Studies 58 (May):529–46.']
  • ['Diba, Behzad T., and Herschel I. Grossman. 1988. Explosive rational bubbles in stock prices? American Economic Review 78 (June):520–30.']
  • ['Evans, George W. 1991. Pitfalls in testing for explosive bubbles in asset prices. American Economic Review 81 (September):922–30.']
  • ['Evans, Martin D. 1996. Peso problems: Their theoretical and empirical implications. In Handbook of statistics, Vol. 14, ed. G. S. Maddala and Calyampudi R. Rao. Amsterdam: Elsevier.']
  • ['Flood, Robert P., and Peter Garber. 1980. Market fundamentals versus price level bubbles: The first tests. Journal of Political Economy 88 (August):745–70.']
  • ['Flood, Robert P., Peter Garber, and Louis Scott. 1984. Multi‐country tests for price level bubbles. Journal of Economic Dynamics and Control 8, no. 2:329–40.']
  • ['Goldfeld, S. M., and R. G. Quandt. 1976. Studies in nonlinear estimation. Cambridge: Ballinger.']
  • ['Hall, Stephen G., Zacharias Psaradakis, and Martin Sola. 1999. Detecting periodically collapsing bubbles: A Markov‐switching unit root test. Journal of Applied Econometrics 14 (March/April):143–54.']
  • ['Kindleberger, Charles P. 1989. Manias, panics and crashes: A history of financial crises. London: Macmillan.']
  • ['Kraus, Alan, and Robert H. Litzenberger. 1976. Skewness preference and the valuation of risky assets. Journal of Finance 31 (September):1085–1100.']
  • ['Maheu, John M., and Thomas H. McCurdy. 2000. Identifying bull and bear markets in stock returns. Journal of Business and Economic Statistics 18:100–12.']
  • ['McQueen, Grant, and Steven Thorley. 1994. Bubbles, stock returns, and duration dependence. Journal of Financial and Quantitative Analysis 29 (September):379–401.']
  • ['Salge, Matthias. 1997. Rational bubbles: Theoretical basis, economic relevance and empirical evidence with a special emphasis on the German stock market. Berlin: Springer‐Verlag.']
  • ['Scott, Robert, and Phillip Horvath. 1980. On the direction of preference for moments of higher order than the variance. Journal of Finance 35 (September):915–19.']
  • ['Shiller, Robert J. 1981. Do stock prices move too much to be justified by subsequent changes in dividends. American Economic Review 71 (May):421–36.']
  • ['———. 2000. Irrational exuberance. Princeton, NJ: Princeton University Press.']
  • ['Summers, Lawrence H. 1986. Does the stock market rationally reflect fundamental values? Journal of Finance 41 (July):591–603.']
  • ['van Norden, Simon. 1996. Regime switching as a test for exchange rate bubbles. Journal of Applied Econometrics 11 (May–June):219–51.']
  • ['van Norden, Simon, and Huntley Schaller. 1993. The predictability of stock market regime: Evidence from the Toronto Stock Exchange. Review of Economics and Statistics 75 (August):505–10.']
  • ['———. 1997. Fads or bubbles? Bank of Canada working paper no. 97‐2.']
  • ['———. 1999. Speculative behavior, regime‐switching, and stock market crashes. In Nonlinear time series analysis of economic and financial data, ed. Philip Rothman, pp. 321–56. Boston: Kluwer.']
  • ['van Norden Simon, and Robert Vigfusson. 1998. Avoiding the Pitfalls: Can regime switching tests reliably detect bubbles? Studies in Nonlinear Dynamics and Econometrics 3 (April):1–22.']
  • ['West, Kenneth D. 1987. A specification test for speculative bubbles. Quarterly Journal of Economics 102 (August):553–80.']