Rational Bubbles in the Indian Stock Market: Empirical Evidence from NSE-500 Index

Bubbles in the stock market have become a much debated topic, especially after the sub-prime crisis of 2007. Rational bubbles can be defined as self-fulfilling expectations that push stock prices towards a level which is unrelated to the change in the market fundamentals. They are usually characterized by a rapid expansion followed by a drastic crash beyond which the prices return back to their mean level. We investigate the presence of rational bubbles in the Indian stock market using monthly stock prices and dividends’ data on CNX-500. We employ a range of linear (symmetric adjustment) and non-linear (asymmetric adjustment) cointegration approaches. We find no evidence of cointegration based on linear approach. However, we reject the null hypothesis of presence of rational bubbles based on non-linear approach. The non-linear approach has a greater power relative to ;linear approach. Hence, the conclusion is indicative of market efficiency. Further, we observe that the negative deviations are eliminated at a faster pace as compared to positive deviations and the stock price, not the dividend is responsible for most of the adjustments back to equilibrium.