Definition
A speculative bubble is a period in which asset prices rise far above any plausible estimate of their fundamental value, sustained by expectations of further price increases rather than by income or cash flows from the underlying assets. Buyers acquire the assets not because of dividends, rents, or use value but because they expect to sell at a higher price later. When that expectation eventually fails — through a trigger event, exhausted credit, or simple loss of nerve — the bubble bursts, often violently.
Historical bubbles are numerous and reliably similar: Dutch tulips (1636-37), the South Sea Bubble (1720), the Railway Mania (1840s), the late-1920s US stock market, Japanese real estate (1986-91), the dot-com bubble (1996-2000), and US housing (2002-06). Each had its rationalisations — "this time is different" — and each ended badly.
Why it matters
How it works
A bubble typically begins with a real change in fundamentals — a new technology (railways, the internet), demographic shift (Japanese real estate demand), or policy change (financial liberalisation). Investors initially respond rationally to the new opportunity. Prices rise; early buyers profit; their gains attract late buyers; leverage extends the rally; speculation takes over from investment.
The bubble continues as long as new buyers (and new credit) keep flowing in. It ends when the marginal buyer's confidence cracks — through bad news, exhausted credit, or simply running out of new entrants. The reversal is usually sudden because everyone wants to sell at once, and because leverage forces selling whether holders want to or not.