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Parsing Speculative Value in Asset Prices

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.

Fields

Macroeconomics, Finance, Time series econometrics, Bayesian econometrics

Other papers

Bubbles, Wage Rigidity, and Persistent Slumps Toan Phan. Economics Letters 2017

Bubbly Recessions Siddhartha Biswas and Toan Phan. American Economic Journal: Macroeconomics forthcoming