Economic bubble

What is an economic bubble?

An economic bubble, also known as an asset-price bubble, occurs when an asset’s price rises above a reasonable estimate of its underlying value, often because buyers expect to sell it to someone else for even more. Identifying one in a real market is difficult: people can disagree about what an asset is worth.

How it works

Rising prices can attract buyers who expect further gains. Their purchases can then push prices higher. This helps explain the attraction of buying into a rising market even when its price is becoming hard to justify.

Smith, Suchanek, and Williams (1988) created laboratory markets where traders knew the dividend structure. In many of those markets, prices rose above the dividend-value benchmark and later fell. Experience reduced the pattern but did not eliminate it.

Why it matters

The experiment puts a difficult market question into a setting where the payoff structure is known. Even there, prices can depart from that benchmark. A price spike in the outside world takes more work to explain: first establish a credible estimate of value, then examine what buyers expected and why they kept buying.