What Are Asset Price Bubbles? A Survey on Definitions of Financial Bubbles

Titelangaben

Janischewski, Anja ; Baumann, Michael Heinrich:
What Are Asset Price Bubbles? A Survey on Definitions of Financial Bubbles.
2021
Veranstaltung: 33rd Annual EAEPE Conference (EAEPE 2021) - European Association for Evolutionary Political Economy , 02.-04. Sept. 2021 , Online.
(Veranstaltungsbeitrag: Kongress/Konferenz/Symposium/Tagung , Vortrag )

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Abstract

Financial market bubbles and crashes have caused large scale economic and social damage, as for example in the 2008 financial crisis and subsequent recession. Also, financial bubbles and crashes have been happening long before that, examples are the Tulipmania in 1637, the Black Thursday in 1929 or the Black Monday in 1987. In order to deal with bubbles, as an investor, a financial regulator, or as an academic researcher, one needs to have precise definitions of what is actually meant by the term asset price bubble. However, definitions across different applications and research areas are ambiguous. We contribute by providing a systematic overview of definitions of asset price bubbles in the literature, including literature branches on rational bubbles, heterogeneous agent models, experimental economics, and mathematical finance. A main distinction is made between definitions that use fundamental values and definitions that refer to price changes over time. For example Kindleberger (1978) defines bubbles as a sharp rise in share prices over a long period of time followed by a sudden crash. On the other hand, many economists prefer to define bubble prices as deviations from fundamental values. This requires the specification of the fundamental value of an asset. The fundamental value can be taken, for example, as the sum of all discounted expected future dividends, the sum of discounted expected future dividends up to a certain point in time plus the expected future value of the asset at that point in time, or retrospectively the sum of realized discounted dividends. Other possibilities would be the total assets (according to the balance sheet or their retail value) divided by the number of shares. There are many challenges in creating a uniform definition of a financial bubble using fundamental values. First, arriving at a unique fundamental value in a theoretical financial market model requires strong assumptions on agents’ knowledge and behavior. In reality, however, financial market participants do not have homogeneous believes about future dividend payments. Thus, depending on the level of abstraction, different definitions of bubbles are needed (see, e.g., Barlevy, 2007). Second, expected future cash flows do not necessary match with the actually paid dividends, when looking back at historical data. Siegel (2003) shows that much of the historic asset prices where actually too low compared to the cash flow that investors received through dividend payments in the subsequent 30 years, which is more or less the duration of the assets. Third, there are assets that do not pay monetary dividends. For example, companies may not pay out any dividends and keep everything in the company. Other firms may pay “dividends,” which are not directly measurable in terms of money, like social or religious banks do. Moreover, there is the question of whether money — irrespective of whether it is paper money, gold, or cryptocurrencies — is a bubble (see Townsend , 1980). Here, other reasons of buying the asset play a role such as using currencies as means of payment — and, in the end, also buying “raw materials,” such as tulips, as a status symbol. Even more than in the case of discounted future dividend payments, the monetary valuations of such utility is subjective. A fourth aspect is the following: If a price is above its fundamental value, this does not mean that it will necessarily fall. But there is also no reason for it not to do so. That is, definitions of bubbles referring to fundamental values do not ask what is really happening, but what could happen (Barlevy, 2007). This idea is followed up in stochastic analysis (e.g., Protter , 2016). If one defines prices as stochastic processes, it is no longer just a price path that is a bubble, but the whole process. That is, it is assumed that the “bubble property” is inherent in the whole dynamic, whether or not “bubble dynamics” are actually observed in a realization of the process. Based on these points, it is evident that a uniform definition of bubble is rather difficult. A potpourri of definitions makes more sense, so that a suitable definition can be found for each application. We examine the definitions of bubble sorted by application areas, which are Monetary Policies, Experimental Economics, Stochastic Analysis, History of Economics, etc., and evaluate the realtime applicability of the definitions, i.e., on the one hand: are the definitions suitable only for theoretical models, for experimental data, or for real world data — and on the other hand: can we detect bubbles only retrospectively or in real time.