Speculative Non-Fundamental Components in Mature Stock Markets: Do They Exist and Are They Related?

Economists have long conjectured that movements in stock prices may involve speculative components, called bubbles. A bubble is defined as the difference between the market value of a security and its fundamental value. The topic of asset bubbles remains controversial because the existence of a bubble is inherently an empirical issue and no satisfactory test has yet been devised to estimate the magnitude of a bubble. This paper proposes a new methodology for testing for the existence of rational bubbles. Unlike previous authors, we treat both the dividend that drives the fundamental part and the nonfundamental process as part of the state vector. This new methodology is applied to the four mature markets of the US, Japan, England, and Germany to test whether a speculative component was present during the period of January 1951 to December 1998 in these markets. The paper also examines whether there are linkages between these national speculative components. We find evidence that the nonfundamental component in the US market causes the other three markets but we find no evidence for reverse causality.