Speculative bubble

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  • Publié le : 16 mai 2010
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Asset price bubble represents a major risk for our global linked economies. Few people are responsible but everybody has to face the brutal consequences of the bubble on the real economy. The subprime crisis drew public opinion against the unrestrained financial system that seems favoured. Media level criticism at the bankers who contribute to widen the gap between rich andpoor people. Nowadays, in people’s mind, finance is assimilated to speculative behaviours led by an endless greed. Throughout modern history, we can count a dozen of serious speculative bubbles for example the Dutch Tulipmania from 1634 to 1637 or the French Mississippi bubble in 1719. What are the tools to struggle with a bubble, according to the economists? Thus, we will try to understand whatan asset price bubble is, the difficulties to foresee the bubble and how a good policy can tackle the deleterious effects of the bubble after its burst.

There is no consensus about the existence of asset price bubbles in the economics world. Well reputed economists claim that even the most famous historical bubbles as well as the worldwide New Economy Boom in the 1990s can be explained byfundamentally justified expectations about future returns of the respective underlying assets. Thus, according to some authors, the observed price developments during the first period of the bubble should not be classified as being excessive or irrational. For example with regard to the New Economy boom of the late 1990s, it has been argued that uncertainty about future earnings prospects increasesthe share value of a company, especially in times of low risk premium. The claim can be derived in a most standard stock valuation model, where the price-dividend ratio is a function of the mean dividend growth rate. The dividend growth rate in turn depends obviously on future expected earnings of the company. Heightened uncertainty about future earnings will increase the price dividend ratio. Ithas further been claimed that assuming apparently reasonable parameter values with regard to the discount rate, expected earnings growth and most importantly the variance of expected earnings growth, one can reproduce the NASDAQ valuation of the late 90s and its huge volatility. There would be no reason to refer to a dotcom bubble. However, if one takes the narrow definition of bubble very oftenused by these economic researchers, there exists a fundamental difficulty in calling an observed asset price boom a bubble: It must be proved that given the information available at the time of the boom, investors processed this information irrationally. This is as the above example shows a formidable task for economists. So that, to prove the existence of a bubble, economists have to wait until theburst of the bubble: it means that an economist can’t prevent a bubble to burst. Ex post, good economists show that they were right. It is very hard to identify bubbles with certainty and almost impossible to reach consensus about whether a particular asset price boom period should be considered a bubble or not.

Economists have often been described as “the great prophets of the past”. Despitethe magnificent words, this appellative is obviously not intended to be a compliment but rather a criticism for not being able to predict the future. After acknowledging the problems to identify a bubble even after the cycle has collapsed, it is not surprising that the challenge to call a boom a bubble represents another order of magnitude if the judgment has to be made in real time, which meanswhen the boom is developing. Prominent economists have even considered this to be an impossible task. For policy makers, the important question is whether we can identify a combination of events in the financial and/or real sectors, which expose the financial system to a significantly increased level of risk. A financial crisis can make it very difficult to maintain price stability. This is...
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