Bubbles and Volatility (Theme 4)

4.5.4?

what is a bubble?

A bubble is a sudden peak in price followed by a collapse (bursting) often caused by herd behaviour

what are the problems of bubbles?

Makes it difficult for businesses to plan when in volatile markets

Higher risks = reduced investment and Aggregate Supply stalling

Consequences for confidence and the economy. Can cause a major recession if a bubble bursts

Effects on the income distribution - investors who get involved later suffer and pension funds possibly

Problems for those who have borrowed and are speculating. ff price collapses, that is a lot of debt to pay back

when can bubbles occur?

inelastic curves (housing market)

new investments

moral hazard exists

there is market manipulation

cheap credit is available

how do we identify a bubble?

price increases rapidly

demand changes are based on confidence - shortages

shares: not linked to profit or RoC

what happens when a bubble bursts?

there is panic selling

prices collapse

recession and bankruptcies

this is all triggered by an event

how does the government stop bubbles?

regulate borrowing and banks

ensure that loans are backed by properly prices assets (especially houses/land)

what is a hedge fund?

an actively managed investment pool whose manager use a wide range of strategies, often including buying with borrowed money and trading esoteric assets, in an effort to beat average investment returns for their clients