The credit crisis of 2007-2009 has been widely attributed to a bubble in home prices, a period when the price rises to unrealistic levels, only to crash thereafter. The Jarrow-Kchia-Protter (âJKPâ) paper notes that controlling price bubbles is essential from a regulatory point of view: William Dudley, the President of the New York Federal Reserve, in an April 9, 2010 interview with Planet Money stated â...what I am proposing is that we try to identify bubbles in real time, try to develop tools to address those bubbles, try to use those tools when appropriate to limit the size of those bubbles and, therefore, try to limit the damage when those bubbles burst."
âThe difficulty in controlling price bubbles in the past has been a significant one,â said Kamakura founder and Chief Executive Officer Donald R. van Deventer, âOne manâs bubble is another manâs âcanât loseâ investment opportunity. The JKP paper is extremely important in providing a firm definition of a bubble which is fully consistent with state of the art mathematical finance and then showing how to apply this bubble detection technology in real time. The authors conclude that stock price movements in LinkedIn following its recent initial public offering could have been detected as a bubble in real time using the JKP approach.â