Speculative Bubbles and the Cross-Sectional Variation in Stock Returns

Evidence suggests that rational, periodically collapsing speculative bubbles may be pervasive in stock markets globally, but there is no research that considers them at the individual stock level. In this study we develop and test an empirical asset pricing model that allows for speculative bubbles to affect stock returns. We show that stocks incorporating larger bubbles yield higher returns. The bubble deviation, at the stock level as opposed to the industry or market level, is a priced source of risk that is separate from the standard market risk, size and value factors. We demonstrate that much of the common variation in stock returns that can be attributable to market risk is due to the co-movement of bubbles rather than being driven fundamentals. EFM classification codes: 310, 330, 350 Acknowledgements: We are grateful to Rajesh Tharyan for providing a list of SEDOL codes matched with those from Datastream, and to Apostolos Katsaris, discussions with whom helped to shape the ideas for this paper.