Academic journal article International Management Review

An Empirical Investigation of Rational Speculative Bubbles in the Jordanian Stock Market: A Nonparametric Approach

Academic journal article International Management Review

An Empirical Investigation of Rational Speculative Bubbles in the Jordanian Stock Market: A Nonparametric Approach

Article excerpt

[Abstract]

This paper examines the presence of rational speculative bubbles in the Jordanian equity market (Amman Stock Exchange, ASE) over a sample period from January 1992 to May 2007 by means of a methodology based on a non-parametric duration dependence test. The results show evidence of negative duration dependence in runs of positive returns, a characteristic consistent with the presence of rational speculative bubbles.

[Keywords] Rational bubbles; duration dependence; ASE; Jordan; JEL classification; G14; Gl5

Introduction

As of December 2006, the market capitalization of the Jordanian stock market (Amman Stock Exchange, ASE) was about $29.73 billion, making it one of the fastest-growing equity market in the in the Middle East and North Africa. In less than a decade, the market capitalization of ASE increased by more than 470%, from $5 billion in 1996. The significant growth of the ASE is a reflection of its attractiveness to both domestic and international investors. The ASE, however, has been interrupted by noticeable bouts of market booms and busts. For example, between 2002 and its peak at the end of 2005, the ASE index rose from a level of 1760.37 to 8191.5 only to collapse abruptly to 5518.1 at the end of 2006. These have prompted some market participants to conjecture that the ASE stock prices are driven by excessive speculation (rational bubbles) rather than the market fundamentals.

Rational speculative bubbles refer to a state in which the price of an asset is based on something other than the market's evaluation of the asset's real value (DeMarzo, et al., 2007). Assert that prices can be driven higher when a few uninformed traders cause an asset price to rise above its fundamental value. Other traders buy the asset with the assumption that the price will rise, and they can sell it before the price drops. This drives the price away from its fundamental value. The result is a short-run bubble, which ultimately ruptures when the price returns to its fundamental value (Kirman & Teyssiere, 2005; Dass, et al., 2007).

Accordingly, in this study, we examine whether equity prices in the ASE were characterized by rational speculative bubbles over the sample period from January 1992 to May 2007. This subject is vital because the detection of rational speculative bubbles can very useful for investors and policymaking decisions. From the investors' point of view, it will make them aware of the size of bubbles that can assist them to detect early signals on the possibility of stock price crash (Brooks & Katsaris, 2005). For the policy-makers, deducing the existence and size of rational bubbles provides several implications to them about how to protect the stock market through manipulating policies that minimize speculative bubbles in the market.

As a speculative bubble is defined as a different between fundamentals determined and observed prices, the main issue is to test the stable relationships among prices and dividends using the cointegration method. The main idea behind this test is that if a rational bubble exists and if the dividends are stationary at the first difference, the first difference of stock prices should be stationary (i.e., stock prices are more explosive than dividends). Conversely, the lack of co-integration between prices and fundamental values is indicative of a rational bubble. This test has been employed in several prior studies including McQueen and Thorley (1994), Chan, et al., (1998), Lavin and Zorn (2001), Harman and Zuelke (2004), and Jirasakuldech, et al. (2008).

However, Evans (1991), Charemza and Deadman (1995), Brooks and Katsaris (2003), Sarno and Taylor (2003), Kanas (2003, 2005), Chang, et al., (2007) and Waters (2007) argue that the traditional co-integration tests are unable to detect an important class of rational bubbles, namely periodically collapsing bubbles, due to the nonlinear characteristics of these types of bubbles. …

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