Detecting stock market bubbles based on the cross-sectional dispersion of stock prices

Takayuki Mizuno, Takaaki Ohnishi and Tsutomu Watanabe
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Takayuki Mizuno: National Institute of Informatics
Takaaki Ohnishi: Graduate School of Information Science and Technology, University of Tokyo
Tsutomu Watanabe: Graduate School of Economics, University of Tokyo

No 10, Working Papers on Central Bank Communication from University of Tokyo, Graduate School of Economics

Abstract: A statistical method is proposed for detecting stock market bubbles that occur when speculative funds concentrate on a small set of stocks. The bubble is defined by stock price diverging from the fundamentals. A firm’s financial standing is certainly a key fundamental attribute of that firm. The law of one price would dictate that firms of similar financial standing share similar fundamentals. We investigate the variation in market capitalization normalized by fundamentals that is estimated by Lasso regression of a firm’s financial standing. The market capitalization distribution has a substantially heavier upper tail during bubble periods, namely, the market capitalization gap opens up in a small subset of firms with similar fundamentals. This phenomenon suggests that speculative funds concentrate in this subset. We demonstrated that this phenomenon could have been used to detect the dot-com bubble of 1998-2000 in different stock exchanges.

Keywords: Stock market; Financial bubble; Nowcast; Power law (search for similar items in EconPapers)
Pages: 9 pages
Date: 2019-08
New Economics Papers: this item is included in nep-rmg
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