Bubble Theory


DEFINITION of 'Bubble Theory'

A school of thought that believes that the prices of assets can temporarily rise far above their true values and that these bubbles are easily identifiable. Former Federal Reserve Chairman Alan Greenspan famously coined the term "irrational exuberance" referring to asset bubbles. Under the bubble theory, large overvaluations of assets can persist for many years, but eventually burst, causing precipitous declines before returning to more reasonable prices.

BREAKING DOWN 'Bubble Theory'

One of the most famous historical examples of an asset bubble is the so-called "tulipmania" in the Netherlands during the 1630s. Contemporary examples include the dotcom bubble in the late 1990s, and the real estate bubble in the U.S. in the late 2000s.

The bubble theory is controversial among those who believe in the theory of efficient markets. Efficient market theorists believe that market participants are rational, and therefore would not buy into asset bubbles if they were readily identifiable. Rather, these theorists argue, clear overvaluations would be driven down to their true value by savvy market participants who would sell the asset, anticipating a decline to the true value.

  1. Tulipmania

    Tulipmania was the first major financial bubble. Investors began ...
  2. Echo Bubble

    A post-bubble rally that becomes another, smaller bubble. The ...
  3. Speculative Bubble

    A spike in asset values within a particular industry, commodity, ...
  4. Housing Bubble

    A run-up in housing prices fueled by demand, speculation and ...
  5. Bubble

    1. An economic cycle characterized by rapid expansion followed ...
  6. Tech Bubble

    A pronounced and unsustainable market rise attributed to increased ...
Related Articles
  1. Home & Auto

    Why Housing Market Bubbles Pop

    Home price appreciation is not assured. Can you withstand the volatility in this market?
  2. Active Trading Fundamentals

    How The Power Of The Masses Drives The Market

    Market psychology is an undeniably powerful force. Find out what you can do about it.
  3. Active Trading

    The Financial Markets: When Fear And Greed Take Over

    If these unpleasant emotions are allowed to influence your decision-making, they may cost you dearly.
  4. Economics

    The Myth About Market Bubbles

    Bubbles have made and ruined fortunes. Though they can be difficult to predict, understanding how they work gives you a visible advantage.
  5. Home & Auto

    Uncover The Next Real Estate Hot Spot

    Real estate land speculation is a way to get in on a hot investment before a boom hits.
  6. Insurance

    Riding The Market Bubble: Don't Try This At Home

    Riding the bubble takes timing, a clear understanding of the market and, most of all, a lot of luck.
  7. Active Trading Fundamentals

    Mad Money ... Mad Market?

    Jim Cramer's spirited recommendations are a case study in irrational market behavior.
  8. Personal Finance

    The Fuel That Fed The Subprime Meltdown

    Take a look at the factors that caused this market to flare up and burn out.
  9. Investing Basics

    3 Key Signs Of A Market Top

    When stocks rise or fall, the financial fate of investors change, as well. There are certain signs that can reveal a stock’s course, and investors don’t need to be experts to spot them.
  10. Professionals

    10 Must Watch Documentaries For Finance Professionals

    Find out about some of the best documentaries that finance professionals can watch to gain a better understanding of their industry.
  1. How do central bank decisions affect volatility?

    Volatility is defined and measured in several different ways, making it somewhat difficult to generalize the impact of central ... Read Full Answer >>
  2. What are the risks of annuities in a recession?

    Annuities come in several forms, the two most common being fixed annuities and variable annuities. During a recession, variable ... Read Full Answer >>
  3. How do mutual funds split?

    Mutual funds split in the same way that individual stocks split, but less often. Like a stock split, mutual fund splits do ... Read Full Answer >>
  4. How does the risk of investing in the industrial sector compare to the broader market?

    There is increased risk when investing in the industrial sector compared to the broader market due to high debt loads and ... Read Full Answer >>
  5. How can I hedge my portfolio to protect from a decline in the retail sector?

    The retail sector provides growth investors with a great opportunity for better-than-average gains during periods of market ... Read Full Answer >>
  6. What is the correlation between term structure of interest rates and recessions?

    There is no question that interest rates have enormous macroeconomic importance. Many economists and analysts believe the ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  2. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  3. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  4. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  5. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  6. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!