Investment Bubbles
In this part, I’d like to talk about investment bubble. Firstly, I will use tulip mania as an example to exemplify this concept, after that I will introduce a few other cases about investment bubble. Finally, I would like to demonstrate some signs that can help to recognize the bubble.
Okay, let’s start with the definition of investment bubble. What is the investment bubble? It’s a kind of price which is much higher than the warranted by the fundamentals. Bubbles usually occur when prices continue increased and this is just because investors believe the investments they buy will upvalue soon.
We can use a very famous example to illustrate this issue, it’s the tulip mania in Holland. How much do you think a tulip bulb could cost? It’s not costly right now, but it could be sold as high as $76,000 then, which was a very crazy phenomenon. But how could this happen?
It started by the first tulip bulb was imported to Holland from Turkey in 1593. After a few years, tulip bulbs became a status symbol of upper classes. And the rapidly rising price quickly attracted speculators looking to profit. By 1634, tulip mania had spread to the middle classes and soon everybody was trading tulip bulbs. (see the diagram)
This mania didn’t end; the peak point came when the tulips were trading on the Stock Exchange. These exchanges started to offer option contracts, which allowed speculators to trade in the tulip bulb market. Options also gave traders the ability to use leverage in their trading which could increase their potential profits dramatically. (see the table)
The Dutch government started to develop regulations to help control the tulip mania. It was at this point that a few informed speculators started to liquidate their tulips bulbs and contracts to lock-in their profits. (Tulip harvest) In less than six weeks, tulip prices crashed by over 90%, causing vast fortunes to be lost.