Job market paper
The link between boom-bust cycles in asset prices and business cycles has been well-documented, but identifying and estimating the bubble component in asset prices remains a challenge. I develop an econometric model combining tools from the affine term structure literature with state-of-the-art models from the rational bubble literature. Employing the FRED-MD monthly database and the U.S. government bond term structure to identify the fundamental value of the S&P 500, along with a particle filter to estimate the bubble component, I find that this model framework matches observed price dynamics very closely. Bubble growth is sensitive to aggregate state and sentiment surprises, particularly with regard to consumer leverage. I apply the model to the current debate regarding the effectiveness of macroeconomic policies for regulating bubbles. I show that traditional contractionary interest rate policy inflates asset price bubbles, whereas a macroprudential policy of leverage tightening deflates asset price bubbles. My framework provides a flexible environment for quantitatively studying bubble magnitude in a broad class of dividend-producing assets and counterfactuals.