Economic (or asset) bubbles form when prices are driven much higher than their intrinsic value (see also efficient market hypothesis). Well-known examples of bubbles include the US Dot-com stock market bubble of the late 1990s and housing bubble of the mid-2000s. According to Robert Shiller (2015), who warned of both of these events, speculative bubbles are fueled by contagious investor enthusiasm (see also herd behavior) and stories that justify price increases. Doubts about the real value of investment are overpowered by strong emotions, such as envy and excitement.

Other biases that promote bubbles include overconfidence, anchoring, and representativeness, which lead investors to interpret increasing prices as a trend that will continue, causing them to chase the market (Fisher, 2014). Economic bubbles are usually followed a sudden and sharp decrease in prices, also known as a crash.

 

Fisher, G. S. (2014). Advising the behavioral investor: Lessons from the real world. In H. K. Barker & V. Ricciardi (Eds.), Investor behavior: The psychology of financial planning and investing (pp. 265-283). New York: John Wiley & Sons.

Shiller, R. J. (2015). Irrational exuberance. Princeton, NJ: Princeton University Press.