Economic Bubble

An economic bubble (also called a speculative bubble, market bubble or financial bubble) is a phenomenon that occurs in markets, largely due to speculation, which is characterized by an abnormal, uncontrolled and prolonged rise in the price of an asset or product, so that said price moves away more and more from the real or intrinsic value of the product. The speculative process leads new buyers to buy in order to sell at a higher price in the future, which causes a spiral of continuous rise and away from any factual basis. The price of the asset reaches absurdly high levels until the bubble ends up bursting (in English crack), due to the beginning of the massive sale of the asset when there are few buyers willing to acquire it. This causes a sudden and abrupt drop in prices, leading to very low prices, even lower than their natural level, leaving behind a lot of debt. This is known as crash.

The economic bubble is often a stock market phenomenon that occurs whenever "high volumes are negotiated at prices that differ considerably from the intrinsic values". The causes bubbles remain a challenge for economic theory. While many explanations have been suggested recently shown that bubbles appear even without uncertainty, speculation, or bounded rationality. More recently, it has been proposed that bubbles may be caused by price coordination processes or emerging social norms.

Because it is often difficult to observe the intrinsic values in real-life markets, bubbles are often identified only retrospectively, when a sudden drop in prices occurs. Such a fall is known as crash or the "bubble burst". Both the economic boom phase and the bubble recession phase are examples of a positive feedback mechanism, in contrast to the negative feedback mechanism that determines the equilibrium price in normal market circumstances. Prices in an economic bubble can fluctuate chaotically and become impossible to predict only based on supply and demand a

It is usually considered that economic bubbles are negative because they entail an inadequate allocation of resources, a good part of them being destined to unproductive ends: the feeding of the bubble. But in addition, the crash with which the economic bubble ends can destroy a large amount of wealth and produce continued unrest, as happened with Dutch tulipomania, the Great Depression of the 1930s and the housing bubble in Japan in the 1990s.

The financial bubbles were studied by Hyman Minsky, who linked them to credit, technological innovations and interest rate variations.

Possible causes

The cause of the bubbles is unknown. It has been proposed that bubbles can be rational, intrinsic, and contagious. To date, there is no widely accepted theory that explains its occurrence.

Disconcertingly, bubbles occur even in highly predictable experimental markets, where uncertainty is eliminated and market participants must be able to calculate the intrinsic value of goods simply by examining the expected dividend flow. However, bubbles have been repeatedly observed in experimental markets, even with sophisticated participants such as managers and professional negotiators. Experimental bubbles have proven their strength in a variety of conditions.

While what causes the bubbles is not clear, there is evidence to suggest that they are not caused by limited rationality or assumptions about the irrationality of others, as assumed by the most foolish theory. It has also been shown that bubbles appear even when market participants are able to price the goods correctly. Moreover, it has been shown that bubbles appear even when speculation is not possible or when overconfidence is absent.

Psychological and social factors

Very popular among laymen, but not completely confirmed by empirical research, theory describes dumbest bubbles as directed by the perennially optimistic behavior of market participants (the fools) who buy overvalued assets anticipating their sale to rapacious speculators (the dumbest) at a much higher price. According to this unsupported explanation, the bubbles continue as long as the fools can find more fools to pay them for the overvalued assets. Bubbles will end only when the dumbest becomes the biggest fool who pays the top price for the overvalued good and can not find another buyer to pay a higher price for it.

Stages of an economic bubble

According to the economist Charles P. Kindleberger, the basic structure of a speculative bubble can be divided into 5 phases:

  • Substitution (displacement): increase of the value of an asset
  • Off (take off): speculative buying (buy now to sell futures at a higher price and make a profit)
  • Critical stage: begin to scarce buyers, some begin to sell.
  • Pop (crash): Plummeting prices.

Most popular economic bubbles

  • Tulipomanía (speculation with the Dutch tulips in the 17th century)
  • Bubble of the South Seas
  • 1929 Crack
  • Financial and real estate bubble in Japan
  • Asian financial crisis
  • Bubble dot com
  • Economic crisis of 2008
  • Real estate bubble in Spain
  • Company of the Mississippi
  • Crack of the cryptocoins of 2018
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