https://cccw.hku.hk/publications/leap/
The paper titled "The Detection and Inspection of Bubbles in the NASDAQ" coauthored by Min Zhu (Founder of the China Global Economic Governance 50 Forum, Senior Fellow at the China Center for International Economic Exchanges, Former Deputy Managing Director of the International Monetary Fund), Siyao Yang ( Postdoctoral Research Fellow at the PBC School of Finance, Tsinghua University) and Bing Gong (Lecturer at the University of Chinese Academy of Social Sciences) was recently published in Leading Edge Academic Publications.
The NASDAQ Composite Index has recently attracted significant global attention due to its strong growth, raising concerns about the potential for bubbles and financial crises. Since 2023, the index has surged dramatically beyond its long-term trend, reminiscent of the pre-crisis periods associated with the Dotcom Bubble in 2000 and the Housing Bubble in 2007.
This study investigates the NASDAQ index's historical booms and busts over the past 50 years, focusing on the Dotcom Bubble around 2000, the Housing Bubble preceding the 2008 financial crisis, and the recent bubble that emerged post-2020. The research validates two key hypotheses: the Connectedness Hypothesis, which posits a close relationship between economic fundamentals and stock dynamics, and the Overshooting Hypothesis, which highlights excessive adjustments in stock prices and returns.
To detect emerging bubbles in the NASDAQ Composite Index, the study employs the Generalized Supremum ADF (GSADF) test. The analysis of identified bubbles is further supported by a Dynamic Stochastic General Equilibrium with Asset Pricing (DSGE-AP) model, which integrates economic fundamentals with financial dynamics. This model identifies three primary drivers of bubbles: unusual market sentiments (stock return shocks), unanticipated technological hype (technological progress shocks), and unexpected credit expansions (monetary policy shocks).
Unlike many contemporary studies that rely on short-term, high-frequency data, this research uses long-period, low-frequency data to detect bubbles, employing the GSADF test for a thorough analysis. This methodology enables a comprehensive comparison of historical bubbles with current index trends, providing a detailed examination of their formation, expansion, and bursting.
Additionally, the study integrates established theoretical frameworks on bubbles with the DSGE model, developing the DSGE-AP model. This model combines rational elements with stochastic shocks to offer insights into the main drivers of NASDAQ bubbles. The paper outlines the use of the GSADF test for bubble detection, the development and application of the DSGE-AP model, and the analysis of bubble drivers. It concludes with strategies for managing market bubbles and maintaining financial stability.
About the authors:
Min Zhu, Founder of the China Global Economic Governance 50 Forum (CGEG50), Former Deputy Managing Director of the International Monetary Fund (IMF), Former Deputy Governor of the People's Bank of China.
Siyao Yang, Postdoctoral Research Fellow at the China Finance Frontier Research Center, PBC School of Finance, Tsinghua University
Bing Gong, Lecturer at the School of International Political Economy, University of Chinese Academy of Social Sciences.
