FINANCIAL ECONOMETRICS ANALYSIS

MBA-441F

CIA-3

Research on conducting a Study on Bubble Testing of

Nifty and Sensex

SUBMITTED BY
K. ROHIT 2028131

UNDER THE GUIDANCE OF

Prof. Badrinath H R

 
MBA PROGRAMME

SCHOOL OF BUSINESS AND MANAGEMENT

CHRIST (DEEMED TO BE UNIVERSITY), BANGALORE

INTRODUCTION:

Bubble has always been coined as a term in financial vocabulary when the asset prices move
up or down drastically from their mathematical valuation (reference) point over an awfully
short time and collapses too in equal or less period of your time. These quite explosive
behaviour in asset prices is Ghosh (2016). Asian Journal of Research in Banking and Finance,
often begin as a result of Herding behaviour within the market. These are called
“destabilizers” in financial terminology, as not only they put a structural break within the
time –series but also, cost of investors goes up rapidly as time is lost. Once in an exceedingly
while, entry of an enormous FII or possibly DII can cause such a shock, but repetitive shocks
in pace could be a signal of approaching bear or possible avalanche breakdown within the
bourses or commodity markets. Behavioural finance has two important concepts, which are
quite aptly linked to the formation similarly as collapse of a bubble. Herding takes a gaggle
of individuals either follow a financial guru, or an eminent fund manager, as an indication of
overconfidence instead of calculation-based decision. The subjective social reality resulting
in distortion, wrong judgement and formation of general opinion or in simple terms like
irrationality are the visible effects of cognitive bias. A phenomenon is well explained by
these, however need for quantification becomes more important, as future prediction of such
incident could save public money entering and exiting the bourses at the crucial point of your
time.

Barlevy (2007) explains it as a phase when the asset price in a very unidirectional manner
exceeds the valuation of that asset to an outsized extent in a very pace. Indian markets, being
a perfect example of weak-efficient economy, information distortion, wrong-judgement,
herding is quite common commodity on offer. So, the necessity for investigating such a
crucial aspect in Indian context becomes quite necessary.

LITERATURE REVIEW:

Many researchers in the past have found extraordinary incident reporting of bubble-spotting
in a very securities market or any such reasonably stochastic statistic with a drift.
Fama (1965) confirmed in the efficient market hypothesis that bubbles cannot exist in
markets yet time and again it absolutely was proven to be incorrect over the past four
decades. Much before this Keynes (1936) has predicted and provided a rationale for such a
bubble with investor irrationality while dealing available markets. Evans (1991) came up
with a theory of periodically collapsing bubbles. Brunnermeier & Abreu (2003) has argued
that bubbles emerge, but not on irrationality rather on wrong pricing of assets. However, they
neither investigated the explanations for forming a bubble nor to time the market and sell
stocks, when it (bubble) becomes evident to everybody. In keeping with Jarrow, Protter &
Shimbo (2007) bubbles will be detected with derivatives against the underlying assets.

If the particular price is quite the rational price, then the presence of a bubble is indicated.
Flavin (1983) and Kleidon (1986) has shown certain criticism like small sample bias and
terminal value bias against the said test.

Diba and Grossman (1988) have used stationarity as a potent tool for bubble detection. This
model relies upon future dividends, expected future stock price, and a few unobserved
variables.

West (1987) has come up with a comparatively simple test where he regressed current stock
price on lagged dividends employing a discount rate and producing an ARIMA equation at
the tip of this study. Gurkaynak (2008) has seen two-gap areas like only past dividends are
taken into consideration and non-stationary (even if it's present) cannot be detected with a
good degree of certainty. Froot & Obstfeld´s (1991) again considered dividend payments;
however, they Ghosh (2016). Asian Journal of Research in Banking and Finance,
differentiated between a rational bubble and intrinsic bubble under their unique model.

According to Gurkaynak (2008), the model should ideally be linear but as log dividend is
taken into account therefore the model is starting up as non-linear, however, Ma and Kanas
(2004) have used this model over a protracted data set folks capital markets over a century
and located it as a far better model while forecasting stock prices with an affordable degree of
accuracy. Van Norden & Vigfusson (1998) captured bubble as more of a variation (could get
on any side) from the basic value with the help of switch regression.

ADF or SADF test to see bubble quite effectively. Phillips, Shi, and Yu (2013) further
extended it to use generalized SADF for efficient bubble prediction. Taipalus (2012) used the
normal Unit Root Test (ADF) and its rolling version i.e., RADF via town simulation on US
exchange data, where he found a proof bubble arising well before 12 months. Sornette et al.
(2010) combined the behavioural theory with the standard rational theory of finance to appear
into two collapses within the Chinese exchange market indexes (SSEC, SZSC) within a time
of 2005 and 2009 by implementing the log-periodic Stevens' power law (LPPL).

PROBLEM STATEMENT:

Speculative price bubbles occur when there is a substantial difference between an asset's
inherent worth and its market value. Later on, these variations become unsustainable, and the
asset's value falls/rises drastically until it is appraised at its actual worth. This phenomenon
displayed by stock prices is critical when doing a technical and fundamental study of the
stock. A considerable lot of work has gone into spotting bubbles in stock price indexes. There
is also the possibility of looking for other similar behaviours displayed by other standard
asset classes.

METHODOLOGY:

The returns were calculated using the formula of ln (current price/ previous days price) of the
index levels. The normalcy was checked using the jarque bera test. Stationarity was checked
through Augmented Dickey-fuller test. To check the breaks multiple break point test was
used.

HYPOTHESIS:

The following research hypotheses were utilized for bubble testing:

H0: The time series do not have a bubble development.

H1: Time series have a bubble development.

DATA AND SOURCES:

Stock market data will be used as the standard to carry out this research. The secondary data
will be stock market levels for the previous three years, which are available daily on Yahoo
Finance. For the study, these daily stock market levels will serve as the independent variable,
while proof of the presence of a bubble over the specified period will function as the
dependent variable.

STATISTICAL TOOLS:

EViews is the statistical software which is necessary to do this research. In EViews, versions
of Right-Tailed Augment Dicky Fuller tests will be utilized to prove the hypothesis and,
hence, a bubble in the time series.

TEST UNDERTAKEN:

Augmented Dickey Fuller test, Rolling ADF, Supremum ADF, Stationarity testing,
Normality testing.

CONCEPTS:

ADF checks stationarity with an autoregressive model; a non-stationary series is differenced

'd' times to become stationary, where 'd' is the order of AR component. Hence, we've to check
at level first, followed by 1st diff and 2nd diff.

ADF is measured from one extreme of the sample to the other extreme. RADF breaks the
sample into various rolling windows and the calculations starts from one extreme of the
sample data to the other but not in continuous manner, each window gets covered one by one
till it reaches the next extreme. SADF or Supremum ADF is done the window size is different
but the starting point for all the windows are the same. So, the sample is veered in 3-4
recursive calculations.

STATIONARITY-

Stationarity refers to a random process that creates a time series whose mean and distribution
are constant through time. Stationarity is important in time series analysis because a
predictable distribution enables forecasting. It is a common assumption of many time series
prediction models.
Stationarity comes with:

1. Unchanged mean and Variance

2. Elasticity of time series

3. Mean reverting nature

4. Mildly explosive exponent

5. Predictability of the time series

SENSEX:

Normality testing:

Jarque bera testing- when the jarque bera score is below 1000 then it is considered to be less
normal. This means that the bell shape isn’t that much peaked.

Kurtosis- when the kurtosis is below 3 then it is considered to platykurtic. This means the
data has small tails and is less volatile.

The sample taken is a stationery data set. The data collected is of daily levels of Sensex from
the time period of 26/9/2018- 26/9/2021, i.e., 3 years. The Jarque bera score of the data set is
65.687 which is low normal. The kurtosis of the dataset is 2.71 which means the tails are low
on the either side. It seems there are many outliers in the data set. The volatility is less and
there were no extreme movements in the Sensex index.

Stationarity testing:
The probability is 95% so null hypothesis is accepted. This means there is non stationarity in
the series.

In AR (1) probability is 0% so alternate hypothesis is accepted. This means there is

stationarity in the series which is positive sign.

In AR (2) probability is 0% so alternate hypothesis is accepted. This means there is

stationarity in the series which is positive sign. So, the series is stationary.

The augmented dickey fuller test was used to know that the closing values have a unit root or
not and also the stationarity of the time series.
BUBBLE TESTING:
Here the probability of the series is less so the null hypothesis is rejected. This means there is
no unit root so there is a bubble in Sensex index. The data is stationery. But the ADF test is
not considered as a full proof test, so we got to do the RADF test and SADF test too.
In the RADF test the probability is less. So, the null hypothesis is rejected. Alternate is
accepted so there is a bubble in the Sensex index. This is second confirmation to the ADF
test’s result.
In the SADF test the probability is less. So, the null hypothesis is rejected. Alternate is
accepted so there is a bubble in the Sensex index.

Hence, we can conclude that there is a bubble development in the time series of the last 3
years.

NIFTY:

Normality testing:

Jarque bera testing- when the jarque bera score is below 1000 then it is considered to be less
normal. This means that the bell shape isn’t that much peaked.

Kurtosis- when the kurtosis is below 3 then it is considered to platykurtic. This means the
data has small tails and is less volatile.

The sample taken is a stationery data set. The data collected is of daily levels of Nifty from
the time period of 26/9/2018- 26/9/2021, i.e., 3 years. The Jarque bera score of the data set is
65.83 which is low normal. The kurtosis of the dataset is 2.78 which means the tails are low
on the either side.
Stationarity testing:

The probability is 96% so null hypothesis is accepted. This means there is non stationarity in
the series.
In AR (1) probability is 0% so alternate hypothesis is accepted. This means there is
stationarity in the series which is positive sign.

In AR (2) probability is 0% so alternate hypothesis is accepted. This means there is

stationarity in the series which is positive sign. So, the series is stationary.

The augmented dickey fuller test was used to know that the closing values have a unit root or
not and also the stationarity of the time series.
BUBBLE TESTING:
Here the probability of the series is below low so the null hypothesis is rejected. This means
there is no unit root so there is a bubble in Nifty index. The data is stationery. But the ADF
test is not considered as a full proof test, so we got to do the RADF test and SADF test too.
In the RADF test the probability is less. So, the null hypothesis is rejected. Alternate is
accepted so there is a bubble in the Nifty index. This is second confirmation to the ADF test’s
result.
In the SADF test the probability is less. So, the null hypothesis is rejected. Alternate is
accepted so there is a bubble in the Nifty index.

Hence, we can conclude that there is a bubble development in the time series of the last 3
years.

CONCLUSION:

This research represents price bubble detection strategies, all based on right tail versions of
the standard reduced form ADF unit root test, where the null of unit root is tested against the
alternative of a mildly explosive process. In this case, rejection of the null for a specific time
series may serve as evidence of the stock market price bubble. This research began with a
short background which was followed by defining the tests and their relevance in the bubble
testing. Each index was tested separately based on the tests defined above. We came to a
conclusion that the Indian stock market has been developing a bubble since last 3 years.

REFERENCES:

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2980795

https://www.researchgate.net/profile/Arghajit-
Mitra/publication/309188275_A_STUDY_ON_RATIONAL_PRICE_BUBBLE_IN_SP_
BSE_SENSEX/links/5803c2b608ae23fd1b689ff3/A-STUDY-ON-RATIONAL-PRICE-
BUBBLE-IN-S-P-BSE-SENSEX.pdf

https://theses.ncl.ac.uk/jspui/bitstream/10443/5000/1/Yu%20G%202019.pdf

https://theses.ncl.ac.uk/jspui/bitstream/10443/5000/1/Yu%20G%202019.pdf

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2980795

https://finance.yahoo.com/quote/%5ENSEI/history?p=%5ENSEI

https://www.bseindia.com/Indices/IndexArchiveData.html