Market bubble and market crash

Turning lead into gold and back into lead

Bubbles or crashes are extreme price rises or falls, notably in financial
markets

Collective
behavioral biases, and also monetary, credit and budgetary
policies
policies leading to overleverage / under leverage can be seen as
the
main causes.

What is the current, or the next, balloon ?
When will it burst ?

Typical traits of those wild market moves

Price bursting like a hand grenade?
Or falling noisily to pieces on the floor?


Market bubbles and crashes are
extreme dynamicmarket price evolutions.

Here we talk about prices typically jumping from 1 to 2 or more,
or plummeting from 1 to .5 or less


Such massive and excessive
market anomalies affect not only prices
but also returns.
No magic here as, for an asset holder, the (positive or negative) return
includes the price variations.


Typically, when those events strike, prices get multiplied or divided by
2 or more in a several months or several years period.

Such extreme variations tend to occur from time to time in any type of
asset markets.
They are typical of bubbles and crashes, which are available in all tastes.
The assets involved can be:
- Equities, bonds, investment funds (*)

- Commodities, currencies (foreign exchange)

- Real estate, and even collectibles.

-
Various kinds of "derivative contracts"
   based on the future price of those assets.
  • bubble  A market bubble occurs when a bull market gets happily
...wild. The price uptrend has persisted unabated (except for
temporary corrections) for a long time (
several years typically)
until reaching
excessively high quotation levels.
  • crash A market crash is a sudden and large price fall.
As if a rubber band breaks suddenly under an accumulated
pressure
It might follow a bubble and signal the start of a bear
market, a downtrend that will lead
to extremely low
prices.
More details on bull and bear markets are given in the
market trends and cycles article.
Yes, bull and bear markets tend to alternate in a
kind of "cycle"

(*) In financial asset markets, stock markets for example,
group herding / herd instinct (trying to buy or to keep
the assets when seeing price rises, and to sell them when seeing
them falls) is stronger than in other markets.


Excesses might increase for a longer time in financial markets
than,  for example, in
commodity markets in which the law
of offer and demand works better.

Here herding has a shorter life: after a while, price rises make
demand fall and price falls attract more demand, just because
"physical users" (except maybe a few wishful thinkers among
them) make cost calculations.

A few causes

Too much pressure?

Those extreme market prices and returns, that usually
stray
from economic fundamentals, are mostly
caused by collective
misreactions and other behavioral
biases - often emotional ones - that affect market players.

Factors seen in bubbles
.
In such cases people tend to speculate with few own
capital
, by getting loans or using financial derivatives.


A persistent inappropriate monetary, credit and budget
policy
can create not only the heating fuel (availability of
cheap and abundant money), but also an artificial belief
in relentless prosperity, or ...a flight from money by
enticing to hoard other assets.
  • Often also in the case of bubbles,incentive illusion gets widespread
that speculation (whether called "trading" or "active
management")
can be riskless, 

Players
might fancy that "stochastic" financial models allow
to fill their pockets with  "alphas" (high returns non correlated
to
risk).
The alchemical illusion based on the belief that ordinary lead
can be safely turned into gold entices the believer
to more
risk-taking.

The craze usually ends in a bad way once it has contaminated
the whole financial system.

Factors seen in crashes

Crashes can be due to external shocks which are:

* either fortuitous
* or voluntary (credit squeeze by central banks that understand,
    a bit late, that the party is getting wild).

But most often, the factor is that investors suddenly realize that

* the debt burden has become unsustainable
* and/or that asset prices have become excessively, even
    madly, high.

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M.a.j. / updated : 27 Sept. 2015
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