Bubbles as Violations of Efficient Time-Scales

25 Pages Posted: 4 Dec 2017

See all articles by H. Sohn

H. Sohn

ETH Zürich

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss Finance Institute; Southern University of Science and Technology; Tokyo Institute of Technology

Date Written: September 18, 2017

Abstract

It is commonly overlooked that the concept of market efficiency embowers a time-dimension. Illustrating with an example from the class of persistent random walks, we show that a price process can be a martingale on one time-scale but inefficient on another. This means that just as market efficiency can only be defined relative to an information set, it also depends on a time-scale. We use this hitherto neglected aspect to propose a new definition of bubbles that does not rely on “fundamental value”: A bubble is a violation of the efficient time-scale in that the market starts to “need longer” to reflect the original information set. That is, just as excess volatility is a violation of market efficiency with respect to its filtration, bubbles are a violation of market efficiency with respect to its time-scale.

Keywords: Bubbles, Efficient markets, Martingales, Persistent random walks, Methodology, Market microstructure

JEL Classification: B26, B41, D53, D84, E44, G12

Suggested Citation

Sohn, H. and Sornette, Didier, Bubbles as Violations of Efficient Time-Scales (September 18, 2017). Institute for New Economic Thinking Working Paper Series No. 65, Available at SSRN: https://ssrn.com/abstract=3081563 or http://dx.doi.org/10.2139/ssrn.3081563

H. Sohn (Contact Author)

ETH Zürich ( email )

Zürich, 8092
Switzerland

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

Scheuchzerstrasse 7
Zurich, ZURICH CH-8092
Switzerland
41446328917 (Phone)
41446321914 (Fax)

HOME PAGE: http://www.er.ethz.ch/

Swiss Finance Institute

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Switzerland

Southern University of Science and Technology

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Shenzhen, Guangdong 518055
China

Tokyo Institute of Technology

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Tokyo 152-8550, 52-8552
Japan

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