1Q 2021 Market and Economic Overview
Asset Price Bubbles Under the efficient market hypothesis, bubbles burst before they even have a chance to emerge. Hence, an asset’s market price should correctly reflect its underlying fundamental value. However, historically, bubbles have emerged as investors are willing to hold assets even when their prices exceeded their fundamental value. They are hoping to sell these assets at an even higher price to some other investor (greater fool) in the future. In a setting in which a single investor alone cannot bring down a bubble, it can be individually rational to ride the bubble. In other words, the uncertainty of not knowing when other investors will start trading against the bubble makes each individual rational investor anxious about whether he can afford to be out of (or short) the market until the bubble finally bursts. Consequently, each investor is reluctant to lean against the bubble and might even prefer to ride it. Thus, price corrections only occur with delay, and often abruptly