A Three-Regime Model of Speculative Behaviour: Modelling the Evolution of the S&P 500 Composite Index

Authors: Brooks, Chris; Katsaris, Apostolos

Source: The Economic Journal, Volume 115, Number 505, July 2005 , pp. 767-797(31)

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Abstract:

We examine whether a three-regime model that allows for dormant, explosive and collapsing speculative behaviour can explain the dynamics of the S&P 500. We extend existing models of speculative behaviour by including a third regime that allows a bubble to grow at a steady rate, and propose abnormal volume as an indicator of the probable time of bubble collapse. We also examine the financial usefulness of the three-regime model by studying a trading rule formed using inferences from it, whose use leads to higher Sharpe ratios and end of period wealth than from employing existing models or a buy-and-hold strategy.

Document Type: Research article

DOI: http://dx.doi.org/10.1111/j.1468-0297.2005.01019.x

Affiliations: 1: Cass Business School

Publication date: 2005-07-01