The laymen’s definition of a speculative bubble rests on hindsight. A lay interpretation of a bubble is merely what happens before a crash!
A rational speculative bubble exists when asset prices become separated from fundamental values, and when investors believe that this will continue. Note that transitory departures from fundamental values, due, perhaps, to changes in conditions of liquidity, to adverse behaviour of market-makers, or to “uninformed” traders’ misperceptions about price, are not speculative bubbles. A necessary characteristic of a rational speculative bubble is that it be self-fulfilling, that either investors are not aware that it exists and so behave in ways that perpetuate it, or investors are indifferent to the existence of the bubble because they believe that a “greater fool” will rescue them from the consequences of overpayment.
- From a paper entitled “Stock market crashes: What have we learned from October 1987?” by Prof. Peter Fortune, the then visiting scholar at Federal Reserve Bank of Boston
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