Identifying speculative bubbles using an infinite hidden Markov model

Shuping Shi*, Yong Song

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

20 Citations (Scopus)

Abstract

This article proposes an infinite hidden Markov model (iHMM) to detect, date stamp, and estimate speculative bubbles. Three features make this new approach attractive to practitioners. First, the iHMM is capable of capturing the complex nonlinear dynamics of bubble behaviors because it allows for an infinite number of regimes. Second, implementing this procedure is straightforward because bubbles are detected, dated, and estimated simultaneously in a coherent Bayesian framework. Third, because the iHMM assumes hierarchical structures, it is parsimonious and superior in out-of-sample forecasts. This model and extensions of this model are applied to the NASDAQ stock market. The in-sample posterior analysis and out-of-sample predictions find evidence of explosive dynamics during the dot-com bubble period. A model comparison shows that the iHMMis strongly supported by the data compared with finite hidden Markov models.

Original languageEnglish
Pages (from-to)159-184
Number of pages26
JournalJournal of Financial Econometrics
Volume14
Issue number1
DOIs
Publication statusPublished - 2016

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