Speculative Bubble

Posted in Finance, Accounting and Economics Terms, Total Reads: 336
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Definition: Speculative Bubble

This kind of bubble results when there is a hike in value of a certain commodity, equity or any other asset class which is driven by the expectation of increased or better future outcome. Subprime mortgage crises of the US was based on a speculative bubble.


People believed that real estate price never go down so banks started lending to subprime lenders who did not have the ability to repay the amount. When the mortgages turned bad, the bubble busted and crises ensued.


Speculative bubbles also result when purchasing derivatives or shorting securities excessively. In the beginning, the hike in prices attracts more and more investors, behavioral theories imply that public doesn’t want to be left behind. But when the real results are not obtained, then the bubble comes to the front and there is outburst of the bubble.


Famous examples of speculative bubble are tulip mania of 1630s and the dotcom bubble of 2000s. In dotcom bubble, hundreds of internet companies were giving positive stock market returns even if they had no earnings to show on income statement. When the bubble burst, many companies went bust as investors withdrew money.

 

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