What is a Bubble?

This keeps coming up over and over again: How do we define what a bubble is?

I am not a fan of the dry academic definitions. Take Nasdaq’s site as an example: They describe a bubble as “A market phenomenon characterized by surges in asset prices to levels significantly above the fundamental value of that asset. Bubbles are often hard to detect in real time because there is disagreement over the fundamental value of the asset.”

Thanks, but what good does that definition do for me? It is an academic explanation – more or less accurate, but mostly useless. It certainly won’t help you as an investor making risk determintions.

Cliff Asness of AQR has a definition I prefer, because of its utility to those deciding whether (and where) to put capital at risk:

Can we discover any ‘reasonable future outcome’ that can justify present prices?

This does not suggest that stocks are cheap or fairly valued or expensive; all it does is force you to hypothesize a future that could rationally justify current valuations.

It is an interesting definition, one worthy of further exploration.

More on this next week . . .





Are We in a Tech Bubble? (February 14, 2020)

Do $100 Million Apartments Mean We Are in a Bubble ? (June 2, 2016)

Do Record Picasso Sales Signal a Bubble? (May 12, 2015)

How a Bubble Steals From the Future  (April 24, 2015)


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