Editing Economic bubble (section)

==Causes==
It has been suggested that bubbles may be rational,<ref>{{cite journal |last=Garber |first=Peter M. |year=1990 |title=Famous First Bubbles |journal=The Journal of Economic Perspectives |volume=4 |issue= 2|pages=35–54 |doi=10.1257/jep.4.2.35 |s2cid=154443701 |doi-access=free}}</ref> intrinsic,<ref>{{cite journal |last=Froot |first=Kenneth A. |author2=Obstfeld, Maurice |year=1991 |title=Intrinsic Bubbles: The Case of Stock Prices |journal=American Economic Review |volume=81 |pages=1189–1214 |doi=10.3386/w3091|doi-access=free}}</ref> and contagious.<ref>{{cite journal |doi=10.2307/2233855 |last=Topol |first=Richard |year=1991 |title=Bubbles and Volatility of Stock Prices: Effect of Mimetic Contagion |journal=The Economic Journal |volume=101 |issue= 407|pages=786–800 |jstor=2233855}}</ref> To date, there is no widely accepted theory to explain their occurrence.<ref name=":0">{{Cite journal|last1=Teeter|first1=Preston|last2=Sandberg|first2=Jorgen|date=2017|title=Cracking the enigma of asset bubbles with narratives|journal=Strategic Organization|volume=15|issue=1|pages=91–99|doi=10.1177/1476127016629880|s2cid=156163200}}</ref> Recent computer-generated agency models suggest excessive leverage could be a key factor in causing financial bubbles.<ref name="Buchanan2008" />

Puzzlingly for some, bubbles occur even in highly predictable experimental markets, where uncertainty is eliminated and market participants should be able to calculate the intrinsic value of the assets simply by examining the expected stream of dividends.<ref name="smithbub">{{cite journal|last=Smith|first=Vernon L.|author2=Suchanek, Gerry L.|author3=Williams, Arlington W.|year=1988|title=Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets|journal=Econometrica|volume=56|issue=5|pages=1119–1151|citeseerx=10.1.1.360.174|doi=10.2307/1911361|jstor=1911361}}</ref> Nevertheless, bubbles have been observed repeatedly in experimental markets, even with participants such as business students, managers, and professional traders. Experimental bubbles have proven robust to a variety of conditions, including short-selling, margin buying, and insider trading.<ref name=":0" /><ref name="robustness">{{cite book|last1=King|first1=Ronald R.|title=Nonlinear Dynamics and Evolutionary Economics|last2=Smith|first2=Vernon L.|last3=Williams|first3=Arlington W.|last4=van Boening|first4=Mark V.|publisher=Oxford University Press|year=1993|isbn=978-0-19-507859-6|editor1-last=Day|editor1-first=R. H.|location=New York|chapter=The Robustness of Bubbles and Crashes in Experimental Stock Markets|editor2-last=Chen|editor2-first=P.}}</ref>

While there is no clear agreement on what causes bubbles, there is evidence{{Citation needed|date=June 2010}} to suggest that they are not caused by [[bounded rationality]] or assumptions about the irrationality of others, as assumed by [[greater fool theory]]. It has also been shown that bubbles appear even when market participants are well capable of pricing assets correctly.<ref name="levineknow">{{cite report |last=Levine|first=Sheen S.|author2=Zajac, Edward J.|date=27 June 2007|title=The Institutional Nature of Price Bubbles|ssrn=960178}}</ref> Further, it has been shown that bubbles appear even when [[speculation]] is not possible<ref name="leinonspec">{{cite journal|last=Lei|first=Vivian|author2=Noussair, Charles N.|author3=Plott, Charles R.|year=2001|title=Nonspeculative Bubbles in Experimental Asset Markets: Lack of Common Knowledge of Rationality Vs. Actual Irrationality|url=https://authors.library.caltech.edu/43956/1/non%20speculative%20bubbles%20in%20experimental.pdf|journal=Econometrica|volume=69|issue=4|pages=831|doi=10.1111/1468-0262.00222|access-date=16 August 2019|archive-date=26 September 2021|archive-url=https://web.archive.org/web/20210926093551/http://authors.library.caltech.edu/43956/1/non%20speculative%20bubbles%20in%20experimental.pdf|url-status=dead}}</ref> or when over-confidence is absent.<ref name="levineknow"/>

More recent theories of asset bubble formation suggest that they are likely sociologically-driven events, thus explanations that merely involve fundamental factors or snippets of human behavior are incomplete at best. For instance, qualitative researchers [[Preston Teeter]] and Jorgen Sandberg argue that market speculation is driven by culturally-situated narratives{{clarify|date=August 2022}} that are deeply embedded in and supported by the prevailing institutions of the time.<ref name=":0" /> They cite factors such as bubbles forming during periods of innovation, easy credit, loose regulations, and internationalized investment as reasons why narratives play such an influential role in the growth of asset bubbles.

===Liquidity===
[[Asset price inflation|One possible cause of bubbles]] is excessive monetary liquidity in the financial system, inducing lax or inappropriate standards of lending by the [[bank]]s, which makes markets vulnerable to volatile asset price inflation caused by short-term, leveraged speculation.<ref name="Buchanan2008">{{cite news |first=Mark |last=Buchanan |title=Why economic theory is out of whack |work=New Scientist |date=19 July 2008 |access-date=15 December 2008 |url=http://forum.globalhousepricecrash.com/index.php?act=attach&type=post&id=4127 |url-status=dead |archive-url=https://web.archive.org/web/20081219004510/http://forum.globalhousepricecrash.com/index.php?act=attach&type=post&id=4127 |archive-date=19 December 2008}}</ref> For example, [[Axel A. Weber]], the former president of the [[Deutsche Bundesbank]], has argued that "The past has shown that an overly generous provision of liquidity in global financial markets in connection with a very low level of interest rates promotes the formation of asset-price bubbles."<ref>{{Cite book|url=https://books.google.com/books?id=snyQDAAAQBAJ&q=%22The+past+has+shown+that+an+overly+generous+provision+of+liquidity+in+global+financial+markets+in+connection+with+a+very+low+level+of+interest+rates+promotes+the+formation+of+asset-price+bubbles.%22&pg=PA33|title=Bubbles and Contagion in Financial Markets, Volume 1: An Integrative View|last=Porras|first=E.|date=2016|publisher=Springer|isbn=978-1137358769|language=en}}</ref>

According to the explanation, excessive monetary liquidity (easy credit, large disposable incomes) potentially occurs while fractional reserve banks are implementing expansionary monetary policy (i.e. lowering of interest rates and flushing the financial system with money supply); this explanation may differ in certain details according to economic philosophy. Those who believe the money supply is controlled [[exogenous variable|exogenously]] by a central bank may attribute an 'expansionary monetary policy' to that bank and (should one exist) a governing body or institution; others who believe that the money supply is created endogenously by the banking sector may attribute such a 'policy' to the behavior of the financial sector itself, and view the state as a passive or reactive factor. This may determine how central or relatively minor/inconsequential policies like [[fractional reserve banking]] and the central bank's efforts to raise or lower short-term interest rates are to one's view on the creation, inflation and ultimate implosion of an economic bubble. Explanations focusing on interest rates tend to take on a common form, however: when interest rates are set excessively low (regardless of the mechanism by which that is accomplished) investors tend to avoid putting their capital into savings accounts. Instead, investors tend to leverage their capital by borrowing from banks and invest the leveraged capital in financial assets such as [[stock]]s and [[real estate]]. Risky leveraged behavior like speculation and [[Ponzi scheme]]s can lead to an increasingly fragile economy, and may also be part of what pushes asset prices artificially upward until the bubble pops.

{{quote box|width=300px|quote=But these [ongoing economic crises] aren’t just a series of unrelated accidents. Instead, what we’re seeing is what happens when too much money is chasing too few investment opportunities.|source=[[Paul Krugman]]<ref>{{cite web |author=Krugman, Paul |date=24 August 2015 |title=A Movable Glut|url=https://www.nytimes.com/2015/08/24/opinion/a-moveable-glut.html?action=click&pgtype=Homepage&module=opinion-c-col-left-region&region=opinion-c-col-left-region&WT.nav=opinion-c-col-left-region |access-date= 24 August 2015|work=[[The New York Times]]}}</ref>}}

Economic bubbles often occur when too much money is chasing too few assets, causing both good assets and bad assets to appreciate excessively beyond their fundamentals to an unsustainable level. Once the bubble bursts, the fall in prices causes the collapse of unsustainable investment schemes (especially speculative and/or Ponzi investments, but not exclusively so), which leads to a crisis of consumer (and investor) confidence that may result in a financial panic and/or financial crisis. If there is a monetary authority like a central bank, it may take measures to soak up the liquidity in the financial system in an attempt to prevent a collapse of its currency. This may involve actions like bailouts of the financial system, but also others that reverse the trend of monetary accommodation, commonly termed forms of 'contractionary monetary policy'.

These measures may include raising interest rates, which tends to make investors become more risk averse and thus avoid leveraged capital because the costs of borrowing may become too expensive. There may also be countermeasures taken pre-emptively during periods of strong economic growth, such as increasing capital reserve requirements and implementing regulation that checks and/or prevents processes leading to over-expansion and excessive leveraging of debt. Ideally, such countermeasures lessen the impact of a downturn by strengthening financial institutions while the economy is strong.

Advocates of perspectives stressing the role of credit money in an economy often refer to (such) bubbles as "credit bubbles", and look at such measures of [[financial leverage]] as [[debt-to-GDP ratio]]s to identify bubbles. Typically the collapse of any economic bubble results in an economic contraction termed (if less severe) a recession or (if more severe) a depression; what economic policies to follow in reaction to such a contraction is a hotly debated perennial topic of political economy.

===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.

===Other===
Some regard bubbles as related to [[inflation]] and thus believe that the causes of inflation are also the causes of bubbles.{{citation needed|date=February 2025}} Others take the view that there is a "fundamental value" to an [[asset]], and that bubbles represent a rise over that fundamental value, which must eventually return to that fundamental value.{{citation needed|date=February 2025}}
There are chaotic theories of bubbles which assert that bubbles come from particular "critical" states in the market based on the communication of economic factors.{{citation needed|date=February 2025}} Finally, others regard bubbles as necessary consequences of irrationally valuing assets solely based upon their returns in the recent past without resorting to a rigorous [[Fundamental analysis|analysis based on their underlying "fundamentals"]].{{citation needed|date=February 2025}}