Bubbles in Asset Prices
The severe world-wide recession of 2008-09 has focused attention on the role of asset-price bubbles in exacerbating economic instability in capitalist economies. The boom in house prices in the United States from 2000 through 2006 is a case in point. According to the Case-Shiller 20-city index, the inflation-adjusted price of a median-sized house in the United States doubled over the period 2000-2006. House prices rose far more than the underlying fundamental drivers of home prices such as family income and rents. The bursting of the bubble was followed by a sharp rise in foreclosures and massive declines in the value of mortgage-backed securities and a variety of derivatives tied to these securities. The collapse of these prices led to the weakening, and in some cases the collapse, of major financial institutions around the world and contributed to one of the most serious recessions in the United States in the entire post-World War II period. The housing bubble is the most recent example of the asset-price bubbles that have often afflicted capitalist economies. Sharp increases in asset prices have frequently led to crashes and subsequent sharp declines in economic activity. Many economists have argued, controversially, that central banks should adjust their policy instruments to account not only for their forecasts of future inflation and the gap between actual and potential output, but for asset prices as well. This paper will address three topics. First, I will describe what economists mean when they use the term bubble, and I will contrast the behavioral-finance view of asset pricing with the efficient-market paradigm in an attempt to understand why bubbles might persist and why they may not be arbitraged away. Second, I will review some major historical examples of asset-price bubbles as well as the (minority) view that they may not have been bubbles at all. I will also examine the corresponding changes in real economic activity that have followed the bursting of such bubbles. Finally, I will examine the most hotly-debated aspect of any discussion of asset-price bubbles: what, if anything, should policy makers do about them? Should they react to sharp increases in asset prices that they deem to be unrelated to fundamentals? Should they take the view that they know more than the market does? Should they recognize that asset-price bubbles are a periodic flaw of capitalism and conduct their policies so as to temper any developing excesses? Or should they focus solely on their primary targets of inflation and real economic activity? In my discussion I will pay particular attention to bubbles that are associated with sharp increases in credit and leverage.
|Date of creation:||Jan 2010|
|Date of revision:|
|Contact details of provider:|| Postal: Princeton, NJ 08544-1021|
Phone: (609) 258-5765
Fax: (609) 258-5398
Web page: http://www.princeton.edu/~ceps/index.htm
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Schwert, G.W., 1988.
"Business Cycles, Financial Crises And Stock Volatility,"
88-06, Rochester, Business - General.
- Schwert, G. William, 1989. "Business cycles, financial crises, and stock volatility," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 31(1), pages 83-125, January.
- G. William Schwert, 1989. "Business Cycles, Financial Crises, and Stock Volatility," NBER Working Papers 2957, National Bureau of Economic Research, Inc.
- De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990.
"Noise Trader Risk in Financial Markets,"
Journal of Political Economy,
University of Chicago Press, vol. 98(4), pages 703-38, August.
- J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, . "Noise Trader Risk in Financial Markets," J. Bradford De Long's Working Papers _124, University of California at Berkeley, Economics Department.
- De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
- Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
- Jensen, Michael C., 1978. "Some anomalous evidence regarding market efficiency," Journal of Financial Economics, Elsevier, vol. 6(2-3), pages 95-101.
- Robert J. Shiller, 2003.
"From Efficient Markets Theory to Behavioral Finance,"
Journal of Economic Perspectives,
American Economic Association, vol. 17(1), pages 83-104, Winter.
- Robert J. Shiller, 2002. "From Efficient Market Theory to Behavioral Finance," Cowles Foundation Discussion Papers 1385, Cowles Foundation for Research in Economics, Yale University.
- Markus K. Brunnermeier & Stefan Nagel, 2004. "Hedge Funds and the Technology Bubble," Journal of Finance, American Finance Association, vol. 59(5), pages 2013-2040, October.
- Hsieh, David A & Miller, Merton H, 1990. " Margin Regulation and Stock Market Volatility," Journal of Finance, American Finance Association, vol. 45(1), pages 3-29, March.
- Kevin J. Lansing, 2008. "Monetary policy and asset prices," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue oct31.
- Michael D. Bordo & Olivier Jeanne, 2002.
"Boom-Busts in Asset Prices, Economic Instability, and Monetary Policy,"
NBER Working Papers
8966, National Bureau of Economic Research, Inc.
- Bordo, Michael D & Jeanne, Olivier, 2002. "Boom-Busts in Asset Prices, Economic Instability and Monetary Policy," CEPR Discussion Papers 3398, C.E.P.R. Discussion Papers.
- Garber, Peter M, 1990. "Famous First Bubbles," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 35-54, Spring.
When requesting a correction, please mention this item's handle: RePEc:pri:cepsud:200malkiel. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (David Long)The email address of this maintainer does not seem to be valid anymore. Please ask David Long to update the entry or send us the correct email address
If references are entirely missing, you can add them using this form.