The long-term risk caused by the stock market bubble

Kasimir Kaliva, Lasse Koskinen

Abstract

ABSTRACT

In this paper we quantify the risk caused by the crash of a pricing bubble in the US stock market by utilizing a recently introduced econometric bubble model. The skewness and kurtosis are shown to vary widely with the price-dividend ratio. Simulation experiments quantify how the moments and value-at-risk of the predictive distribution depend on the holding period, the price-dividend ratio and inflation. This information is useful in deciding on market timing and needed risk capital. In addition the analysis of higher moments supports the old wisdom that stocks are a more attractive investment in the long run than in the short run.