The Four Causes of Speculative "Bubbles" Essay

The Four Causes of Speculative "Bubbles" Essay

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Why do some technologies lead to speculation while others do not? Why were there speculative bubbles in stocks of early radio producers and broadcasters, “aeroplane” manufacturers and airlines, internet storefronts, electronics producers, electric automobile manufacturers, and transcontinental railroads, but not in the stocks of producers of lasers, northeastern railroads, antibiotics, nylon, rayon, cellophane, or televisions?
Our proposed work aims to rectify an important methodological flaw in current studies of speculative crises: one cannot identify the causes of bubbles by examining a single case, nor can one identify bubbles based on an analysis of bubbles throughout history. Instead, one must look at cases where there were, and were not bubbles. Identifying causal factors requires (i) a sampling strategy that encompasses episodes of financial euphoria and periods of relative calm and (ii) the identification of assets that are at similar risk of sparking such speculative episodes. In this paper, we develop an inventory of technological innovations that ex post were revealed to be of substantial economic importance. Our initial findings are that bubbles appear under four important conditions.
First, consistent with prior research (see esp. Kindleberger, 2005), there must be easy access to credit. Bubbles are rare when interest rates are high.
Second, as argued extensively in the financial economics and the economics literature generally, assets that serve as foci of speculative behavior possess high levels of commercial and technological uncertainty (cf., Baker & Wurgler, 2007). The results we observe are consistent with the theoretical finding that uncertain opportunities may warrant high prices due to their high opt...


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...ar press, or through existing historical accounts. Through our pilot study, we have demonstrated variance in the formation of asset bubbles surrounding the introduction of significant new technologies. While we find general support for our predictions, the current stage of this work is rudimentary: much work is left to be done.
In addition to contributing to an important stream of research, this research has broad implications for public and private policy makers. The pervasive influence of asset bubbles on resource allocation suggests the need for increased understanding of the causes of these episodes. While entrepreneurs and investors may wish to exploit this knowledge to more effectively mobilize capital in support of innovation, regulators and other public authorities need to understand and monitor the mechanisms that can lead to destructive financial events.

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