Abstract

This paper posits that when an asset exhibits a bubble, the time series of its prices can explode with positive probability if a quadratic variation (QV) risk premium is large enough. This QV channel for bubble explosion is new to the literature. Based on the local martingale theory of bubbles, we provide sufficient conditions under which this QV explosion can occur. We also identify another possible explosion due to an autoregressive (AR) drift. Using the S&P 500 index and a sample of individual stocks over 1996-2021, we document the existence of price bubbles and test for the existence of price explosions. Almost all price explosion episodes discovered are associated with QV and not AR drift channel.