Bubbles’ are much in debate by the Analysts,Economists and the fellow financial media, Emerging markets, NAMO wave, FIFA 2014, Dubai Property blogprices and so on.

A key issue, obviously, is what is a bubble.

The Brunnermaier definition is

Bubbles are typically associated with dramatic asset price increases followed by a collapse. Bubbles arise if the price exceeds the asset’s fundamental value. This can occur if investors hold the asset because they believe that they can sell it at a higher price to some other investor even though the asset’s price exceeds its fundamental value. 

I think this is a terrible definition. There are two big things wrong with it:

  • It implies that an asset price rise is only a bubble if it is followed by a collapse, in other words that, by definition, slow bubble deflation is impossible.
  • It assumes that there is a single ‘fundamental’ price which we can measure deviations from. In reality of course ‘fundamentals’ are just as socially constructed as market prices, and just as arbitrary.

We can’t reasonably hope to address the financial stability implications of bubbles until we have a better definition of what a bubble is.