Introduction to Stock Market Bubble
A Stock Market Bubble is a condition in stock market when prices for a stock or an asset rise excessively over a period of time. When a price for an asset outperforms the asset’s intrinsic value, a bubble rises. Basically, speculation is the major drive force to any bubble creation.
When investors are expecting prices to increase, they bid up for the price irrationally to maximize the utility of the market. This behavior lead investors to pay more and more for a security beyond what is expected. Another reason why bubble is created in a stock market is investors’ fear of missing out. When prices are volatile, everyone wants to invest and cash-in. This lead to excessive involvement in stock transaction, more and more people want to buy it, gearing up the prices of assets above its anticipated value.
Characteristics of Stock Market Bubble
Speculation and rise of stock price above its intrinsic value are some of the common characteristics of Stock Market Bubbles. Some of the other distinctive characteristics are as follows:
- Investors are always optimistic about the market. When bubble is in making, investors always consider the current bubble to be different than previous past bubbles which collapsed. This careless abrupt investment and overconfidence in market ends painful.
- Over evaluated stock and growth stories. This is another characteristics of securities at bubble. Every stock is potential stock and there is domino effect in every stock. During dotcom bubble, majority of the tech companies have excellent growth stories. Similarly, during the Real Estate Bubble of early 2000 made everyone invest in real estate, over valuing the entire industry.
- Market participants are dependent on authorities for regulation of market. This is another significant feature of stock market bubble. Participants involve in stock transaction considering that all the financial and market risk are accessed by the authorities and market is risk free. This promotes the irrational behavior of investment and promotes bubble.
- Easy and Quick Money. Speculative investment promotes bubble in the market. Hence, the prices of securities are always increases. “Buy now, sell tomorrow” is the mantra as everyone is quite sure that prices will increase unless the bubble burst. Hence, most of the people enjoys good return in bubble. No news affect the price of stock,
- Bubble growth defies and denies every rational valuation techniques. When investment is based on speculation, every investor is looking for quick and short term effect. The investment decision is dependent on such speculation. Hence, investors do not consider any valuation techniques while making an investment. The irrational increase in prices of stock are prevalent to that during a stock market bubble.
- Substandard Financing and Investment. In the Stock Market Bubble, when prices are going crazily up, everyone cares about the return. Investors are investing because prices are optimistically rising. There is no assurance about credit quality and standards. The quantity of credit is more concerning than the quality of the credit.
Example of Stock Market Bubble
- Japan’s Real Estate and Stock Market Bubble
- The Dotcom Bubble