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- Title
Inferring financial bubbles from option data.
- Authors
Jarrow, Robert A.; Kwok, Simon S.
- Abstract
Summary: Financial bubbles arise when the underlying asset's market price deviates from its fundamental value. Unlike other bubble tests that use time series data and assume a reduced‐form price process, we infer the existence of bubbles nonparametrically using option price data. Under no‐arbitrage and acknowledging data constraints, we can partially identify asset price bubbles using a cross section of European option prices. In the empirical analysis, we obtain interval estimates of price bubbles embedded in the S&P 500 Index. The estimated index bubbles are then used to construct profitable momentum trading strategies that consistently outperform a buy‐and‐hold trading strategy.
- Subjects
ECONOMIC bubbles; TIME series analysis; ARBITRAGE; MARKET pricing; NONPARAMETRIC estimation; TIME management
- Publication
Journal of Applied Econometrics, 2021, Vol 36, Issue 7, p1013
- ISSN
0883-7252
- Publication type
Article
- DOI
10.1002/jae.2862