An Application of the “Recursive Flexible Window” Methodology to Test for Financial Bubbles in a Major Stock Market

Abstract

Identifying and dating financial bubbles in real time is in the forefront of current empirical research. Their accuracy provides real time useful “warning alerts” to central bankers and fiscal regulators. The complexity of their nonlinear structure and the inherent sudden break mechanisms makes the econometric testing challenging. The new recursive flexible window methodology provided by Phillips, Shi, and Yu (2015) gives consistent results and delivers significant power gains when multiple bubbles occur. It successfully identifies well-known historical episodes of exuberance and collapse. In this paper we look at the Indian stock market indices, the SENSEX, and the NIFTY 50, to see if there is any evidence of a bubble there. We use monthly data for each series, with the Sensex data spanning April 1979 to October 2018 and NIFTY 50 data spanning July 1990 to October 2018. The existence of bubbles in this index will give us some indication of where bubbles are more likely to occur, and therefore provide evidence of potential economic (financial) crises.