Speculative bubble: what is it – Dictionary of Economics

Historically, of all those to date, the best known or most analyzed have been those of the Dutch ‘tulipomania’, the Great Depression of the 1930s, and the real estate bubble in Japan in the 1990s.

Speculative bubbles, also called financial or market bubbles, are a phenomenon that arises in the markets themselves, most of the time, if not all, as a result of speculation (hence the name of speculative bubbles).

We speak of the existence of a bubble of a certain asset, when that element is experiencing a prolonged and abnormal rise in its price, in such a way that the price it is receiving moves further and further away from its equilibrium price in the market or, perhaps, of its real or intrinsic value.

It is a dynamic process that, sometimes unrestrained, leads to new buyers in the hope or idea of ​​being able to sell that product at a higher price in the future. This process causes a real spiral of continuous increases in price.

Once the asset price has reached unreasonably high levels – what a well-known Federal Reserve chairman, Alan Greespan, called “irrational exuberance”, it will explode.

The unleashing of fear, sometimes panic, gives rise to the massive sale of the asset, at a time when there are precisely few buyers, but quite the opposite.

The crash or bursting of the bubble causes a sharp drop in prices, taking it to really very low prices, which can even reach levels lower than what its most natural price would be.

Possible causes of speculative bubbles

As in other aspects, there is no agreement among economists regarding a valid theory to explain the causes of the appearance of this economic phenomenon.

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Some studies show that bubbles, in some cases, can appear even without being in a speculative or irrational gap.

As a consequence of the traditional difficulties of economists or the impossibility of being able to know exactly the intrinsic or correct values ​​that should be formed in the markets, they are often studied only a posteriori, and therefore, interpreted retrospectively. Even frequently, when some analysts detect them, they glimpse on the horizon, others appear who deny it, perhaps fearful of suffering losses in their portfolio of assets, if they integrate the product or element in question.

The mechanisms, both in the phase of the ascending boom in prices, and in that of the “puncture”, are very illustrative examples of the functioning of social feedback phenomena. However, during the bubble, prices usually have chaotic components that make it difficult or impossible to make accurate forecasts regarding their more or less close evolution.

It is generally accepted by economists that bubbles are a cause of misallocation of resources, destroying a considerable amount of wealth, and a very pronounced malaise.

Surprisingly, bubbles even tend to appear in the most predictable markets, where uncertainty is eliminated and market participants must be able to calculate the intrinsic value of assets simply by examining the expected dividend stream, as is the case with the Stock Market.

A curious theory: the theory of the dumbest.

A very popular theory, although not empirically tested, is the so-called “dumbest theory”.

This theory describes bubbles as driven by the eternally optimistic behavior of market participants. These are the so-called fools – who buy overvalued assets in anticipation of their sale to rapacious speculators – even more foolish – at a much higher price.

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Consequently, the bubbles will continue as long as “the fools” can find “more fools” willing to pay them a price for the overvalued asset. The bubbles will end only when the “dumbest” becomes the “biggest dumb” who pays the premium price for the overvalued good and cannot find an even dumber buyer who pays a higher price for it.

Economist Charles P. Kindleberger has typified the different stages of bubbles:

Main phases or stages of the bubbles:

• 1st stage: Substitution (displacement): increase in the value of an asset

• 2nd stage: take off: speculative purchases (buy now to sell in the future at a higher price and make a profit)

• 3rd stage: Exuberance (exuberance).

• 4th stage: Critical (critical stage): buyers begin to be scarce and some begin to sell.

• 5th stage: Explosion (crash).

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