Our word of the day is “Bubble”

A Bubble begins when the price of an asset rises far higher than can be explained by

fundamentals, such as the income likely to derive from holding the asset. The Chicago

Tribune of April 13th 1890, writing about the then mania in real-estate prices, described

"men who bought property at prices they knew perfectly well were fictitious, but who were

prepared to pay such prices simply because they knew that some still greater fool could

be depended on to take the property off their hands and leave them with a profit". Such

behavior is a feature of all bubbles. Famous bubbles include tulip mania in Holland

during the 17th century, when the prices of tulip bulbs reached unheard of levels, and

the South Sea Bubble in Britain a century later, although there have been many others

since, including the dotcom bubble in internet company shares that burst in 2000. Economists

argue about whether bubbles are the result of irrational crowd behavior perhaps coupled

with exploitation of the gullible masses by some savvy speculators or, instead, are the

result of rational decisions by people who have only limited information about the fundamental

value of an asset and thus for whom it may be quite sensible to assume the market price

is sound. Whatever their cause, bubbles do not last forever and often end not with a

pop but with a crash.