I have a pet theory I'd like your thoughts on.
Bubbles burst primarily due to the law of large numbers.
Indulge me, if you will π
Bubbles burst primarily due to the law of large numbers.
Indulge me, if you will π
Let's start by setting clear definitions:
Bubble: market price of an asset that's far beyond what fundamentals justify.
Bubble: market price of an asset that's far beyond what fundamentals justify.
Law of large numbers (in finance): In a financial context, the law of large numbers indicates that a large entity which is growing rapidly cannot maintain that growth pace forever
A bubble is inflated by speculators who've latched onto a story. The fundamentals don't justify the story "yet" but the story will eventually bare out.
As the story gains traction, the asset's price accelerates. Rapid wealth creation attracts even more speculators / believers.
As the story gains traction, the asset's price accelerates. Rapid wealth creation attracts even more speculators / believers.
However, at some point, the asset's market value gets so large that price appreciation slows down to single digits. This deflates the excitement "story believers" have. It also discourages speculators who only bet money expecting double or triple-digit growth
Since the fundamentals don't justify the price, value investors and wealth preservers won't touch the asset either. Effectively, the bubble runs out of room and has no option but to deflate.
TLDR: When the asset price movements become boring and below 10%, while the fundamentals still haven't caught up, bubbles burst
β’ β’ β’
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