Detecting Mysticism in Asset Markets by George Waters published by Journal of Economic Dynamics & Control (12/2025).
The model of endogenous rational bubbles (ERB) uses a weighted replicator dynamic to describe the evolution of heterogeneous forecasting strategies and can produce bubbles when agents are sufficiently aggressive about switching to better performing strategies. The Generalized Sup Augmented Dickey Fuller (GSADF) test is the most reliable test for detecting bubbles and is capable of dating multiple bubbles in a sample. The model of ERB can produce empirically realistic bubbles, and the GSADF test can detect and date them. The choices of parameter values have behavioral interpretations for the frequency, magnitude and duration of the bubbles. The interaction between the theoretical and empirical approaches suggests a bubble definition based on magnitudes of the deviations and the autocorrelation of the price-dividend ratio.
