A recursive regression methodology is used to analyze the bubble characteristics of various financial time series during the subprime crisis. The methods provide a technology for identifying bubble behavior and consistent dating of their origination and collapse. Seven relevant financial series are investigated, including three financial assets (the Nasdaq index, home price index and asset-backed commercial paper), two commodities (the crude oil price and platinum

The revaluation of collateralized debt obligations (CDOs) plays a significant role in the ongoing 2007-2009 credit crisis. Starting in August 2007, a large amount of initially AAA rated CDO securities are substantially downgraded, some directly to junk grade. This paper explores two structural sources of CDO mispricing: modeling difficulty and data limitation. Simulating the frailty correlated default model of Duffie, Eckner, Horel, and Saita (2008), we show that CDO mis-pricing can be partly attributed to model misspecifications, as well as limited availability of historical data on CDO collateral assets. This simulation result is consistent with empirical evidence on historical performance of a sample of 279 CDOs. The frailty model estimated with adequate historical data would have reduced the amount of AAA rated CDO securities by 12 % on average. The frailty model has predictive power for the subsequent downgrading of AAA rated CDO tranches. Our study addresses practical issues on financial innovations and provides guidance for corresponding risk management. We thank for remarks from Andrew Carverhill, Wing Suen and seminar participants at the university

A new recursive regression methodology is introduced to analyze the bubble characteristics of various …nancial time series during the subprime crisis. The methods modify a technique proposed in Phillips, Wu and Yu (2010) and provide a technology for identifying bubble behavior and consistent dating of their origination and collapse. The tests also serve as an early warning diagnostic of bubble activity. Seven relevant …nancial series are investigated, including three …nancial assets (the Nasdaq index, home price index and asset-backed commercial paper), two commodities (the crude oil price and platinum price), one bond rate (Baa), and one exchange rate (Pound/USD). Statistically signi…cant bubble characteristics are found in all of these series. The empirical estimates of the origination and collapse dates suggest an interesting migration mechanism among the …nancial variables: a bubble …rst emerged in the equity market during mid-1995 lasting to the end of 2000, followed by a bubble in the real estate market between January 2001 and July 2007 and in the mortgage market between November 2005 and August 2007. After the subprime crisis erupted, the phenomenon migrated selectively into the commodity market and the foreign exchange market, creating bubbles which subsequently burst at the end of 2008, just as the e¤ects on the real economy and economic