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The behaviour of commodity prices and U.S./European housing market prices in 2008, the ‘dot-com’ boom in 1998-2000, all these events have been characterized as speculative price bubbles: persistent deviations from assets’ fundamental values with strong increases in asset prices in a continuous process. They are possibly the most controversial subject of finance, not only for the implications to risk management, but because their existence contradicts the assumptions of the Efficient Market Hypothesis (EMH).
Although some critics challenge the very existence of bubbles, even questioning the empirical tests developed in recent years, several studies have been carried out concerning speculative bubbles, and it is undeniable that the coexistence of high prices, high trading volumes and high volatility is not consistent with the assumptions of EMH, hence the need to use an alternative approach – behavioural finance – in order to better explain this phenomenon. This article aims to compare two approaches to bubble prices: one based on the EMH, the other based on a behavioural approach.
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The behaviour of commodity prices and U.S./European housing market prices in 2008, the ‘dot-com’ boom in 1998-2000, all these events have been characterized as speculative price bubbles: persistent deviations from assets’ fundamental values with strong increases in asset prices in a continuous process. They are possibly the most controversial subject of finance, not only for the implications to risk management, but because their existence contradicts the assumptions of the Efficient Market Hypothesis (EMH).
Although some critics challenge the very existence of bubbles, even questioning the empirical tests developed in recent years, several studies have been carried out concerning speculative bubbles, and it is undeniable that the coexistence of high prices, high trading volumes and high volatility is not consistent with the assumptions of EMH, hence the need to use an alternative approach – behavioural finance – in order to better explain this phenomenon. This article aims to compare two approaches to bubble prices: one based on the EMH, the other based on a behavioural approach.
read ahead