Editing Economic bubble (section)

===Psychology===

====Greater fool theory====
{{main|Greater fool theory}}
[[Greater fool theory]] states that bubbles are driven by the behavior of perennially optimistic market participants (the fools) who buy overvalued assets in anticipation of selling it to other speculators (the greater fools) at a much higher price. According to this explanation, the bubbles continue as long as the fools can find greater fools to pay up for the overvalued asset. The bubbles will end only when the greater fool becomes the greatest fool who pays the top price for the overvalued asset and can no longer find another buyer to pay for it at a higher price.  This theory is popular among laity but has not yet been fully confirmed by empirical research.<ref name="leinonspec"/><ref name="levineknow"/>

====Extrapolation====
{{quote box|width=300px|quote= The term "bubble" should indicate a price that no reasonable future outcome can justify.|source=[[Clifford Asness]]<ref>{{cite web |author=Righoltz, Barry |date=6 December 2013 |title=How do you define a bubble?|url=https://www.bloomberg.com/view/articles/2013-12-06/how-do-you-define-a-bubble-and-are-we-in-one-now-|access-date= 11 November 2016|publisher=[[Bloomberg L.P.|Bloomberg]]}}</ref>}}
[[Extrapolation]] is projecting historical data into the future on the same basis; if prices have risen at a certain rate in the past, they will continue to rise at that rate forever. The argument is that investors tend to extrapolate past extraordinary returns on investment of certain assets into the future, causing them to overbid those risky assets in order to attempt to continue to capture those same rates of return.

Overbidding on certain assets will at some point result in uneconomic rates of return for investors; only then the asset price deflation will begin.  When investors feel that they are no longer well compensated for holding those risky assets, they will start to demand higher rates of return on their investments.

====Herding====
Another related explanation used in [[behavioral finance]] lies in [[herd behavior]], the fact that investors tend to buy or sell in the direction of the market trend.<ref>{{cite journal |last1=Harmon |first1=D |last2=Lagi |first2=M |last3=de Aguiar |first3=MAM |last4=Chinellato |first4=DD |last5=Braha |first5=D |last6=Epstein |first6=IR |display-authors=etal |year=2015 |title=Anticipating Economic Market Crises Using Measures of Collective Panic |journal=PLOS ONE |volume=10 |issue=7 |page=e0131871 |doi=10.1371/journal.pone.0131871 |pmid=26185988 |pmc=4506134 |bibcode=2015PLoSO..1031871H |doi-access=free}}</ref><ref>{{Cite magazine |last=Keim |first=Brandon |title=Possible Early Warning Sign for Market Crashes |language=en-US |magazine=Wired |url=https://www.wired.com/2011/03/market-panic-signs/ |access-date=2023-08-11 |issn=1059-1028}}</ref> This is sometimes helped by [[technical analysis]] that tries precisely to detect those trends and follow them, which creates a [[self-fulfilling prophecy]].

Investment managers, such as stock [[mutual fund]] managers, are compensated and retained in part due to their performance relative to peers. Taking a conservative or contrarian position as a bubble builds results in performance unfavorable to peers.  This may cause customers to go elsewhere and can affect the investment manager's own employment or compensation. The typical short-term focus of U.S. equity markets exacerbates the risk for investment managers that do not participate during the building phase of a bubble, particularly one that builds over a longer period of time. In attempting to maximize returns for clients and maintain their employment, they may rationally participate in a bubble they believe to be forming, as the likely shorter-term benefits of doing so outweigh the likely longer-term risks.<ref>{{cite web|url=https://www.theatlantic.com/doc/200812/blodget-wall-street|title=Why Wall Street Always Blows It|first=Henry|last=Blodget|website=[[The Atlantic]]|access-date=31 August 2017|date=December 2008}}</ref>

====Moral hazard====
[[Moral hazard]] is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. A person's belief that they are responsible for the consequences of their own actions is an essential aspect of rational behavior. An investor must balance the possibility of making a return on their investment with the risk of making a loss – the [[Risk-return spectrum|risk-return]] relationship. A moral hazard can occur when this relationship is interfered with, often via [[government policy]].

A recent example is the [[Troubled Asset Relief Program]] (TARP), signed into law by U.S. President [[George W. Bush]] on 3 October 2008 to provide a government bailout for many financial and non-financial institutions who speculated in high-risk financial instruments during the housing boom condemned by a 2005 story in ''[[The Economist]]'' titled "The worldwide rise in house prices is the biggest bubble in history".<ref>{{cite news |title=In come the waves: The worldwide rise in house prices is the biggest bubble in history. Prepare for the economic pain when it pops. |newspaper=[[The Economist]] |date=16 June 2005 |url=http://www.economist.com/opinion/displaystory.cfm?story_id=4079027 |quote=The worldwide rise in house prices is the biggest bubble in history. Prepare for the economic pain when it pops.}}</ref> A historical example was [[Tulip mania#Legal changes|intervention by the Dutch Parliament during the great Tulip Mania of 1637]].

Other causes of perceived insulation from risk may derive from a given entity's predominance in a market relative to other players, and not from state intervention or market regulation. A firm – or several large firms acting in concert (see [[cartel]], [[oligopoly]] and [[collusion]]) – with very large holdings and capital reserves could instigate a market bubble by investing heavily in a given asset, creating a relative scarcity which drives up that asset's price. Because of the signaling power of the large firm or group of colluding firms, the firm's smaller competitors will follow suit, similarly investing in the asset due to its price gains.

However, in relation to the party instigating the bubble, these smaller competitors are insufficiently leveraged to withstand a similarly rapid decline in the asset's price. When the large firm, cartel or ''de facto'' collusive body perceives a maximal peak has been reached in the traded asset's price, it can then proceed to rapidly sell or "dump" its holdings of this asset on the market, precipitating a price decline that forces its competitors into insolvency, bankruptcy or foreclosure.

The large firm or cartel – which has intentionally leveraged itself to withstand the price decline it engineered – can then acquire the capital of its failing or devalued competitors at a low price as well as capture a greater market share (e.g., via a [[Mergers and acquisitions|merger or acquisition]] which expands the dominant firm's distribution chain).  If the bubble-instigating party is itself a lending institution, it can combine its knowledge of its borrowers' leveraging positions with publicly available information on their stock holdings, and strategically shield or expose them to default.