How do Market “Bubbles” Burst?

Bubbles, while both intriguing and puzzling occurrences, have always been a part of market and economic cycles.

In short, a bubble forms when investors start bidding up the price of an asset well beyond its intrinsic value, based on speculation and euphoria surrounding potential gains.

Eventually demand will dry up when valuations are too high, as investors start shunning the risk premium associated with investing. Investors will then race to be the first out of the position, and it ultimately brings all the sellers to the table at once. The bubble then pops.

The most famous sentence describing bubbles belongs to the former chairman of the Federal Reserve Board, Alan Greenspan, who coined the phrase “irrational exuberance” during the stock market rise of the 1990’s.

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