Investing

What Are Asset Bubbles? (Video)

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(picture courtesy of cartoonstock.com)

An economic bubble (also called speculative bubble, market bubble or financial bubble) is a phenomenon that occurs in markets, largely due to speculation, characterized by an abnormal and prolonged rise in the price of an asset or product such that the price is moving further away 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 due to the beginning of the massive sale of the asset when few buyers are willing to buy it. This causes a sudden and drastic drop in prices even below their natural level, leaving behind a trail of debt. This is known as crash.

The economic bubble is often a stock market phenomenon that occurs whenever high volumes are traded at prices that differ considerably from intrinsic values. The causes of bubbles remain a challenge to economic theory. Although many explanations have been suggested, it has recently been shown that bubbles appear even without uncertainty, speculation, or limited rationality.

Because intrinsic values ​​are often difficult to observe in real-life markets, bubbles are often identified only retrospectively when a sudden drop in prices occurs. Such a fall is known as a crash or the “burst of the bubble.” Both the economic boom phase and the bubble recession are examples of a positive feedback mechanism, in contrast to the negative feedback mechanism that determines the equilibrium price under normal market circumstances.

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

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