Quote:
Originally Posted by Cowboy89
Yes. Efficient Market Hypothesis assumes that all possible public information about a stock or asset is taken into account and priced into the asset at any given time and that all purchasers/sellers are perfectly rational and understand the fundamentals of the asset.
Bubbles occur when people buy for no other good reason than 'this asset has been going up' and the mass effect of all those people diving in for that very reason creates a positive feedback cycle that can go on basically as long as buyers have capacity to buy more.
The opposite can happen in crashes, where people sell , just out of fear it will go down more.
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There are really four types of bubbles:
1. Rational/Near Bubbles: people know that the bubble will collapse, but don't know when. The prices increase because while people know its a bubble the compensation for that risk increases as well.
2. Intrinsic Bubbles: This is where people use fundamentals and either over-react to the news or extrapolate that information to suggest ever increasing prices/growth.
3. Fads: This is basically the "this time is different" way of thinking, or a things can never change way of thinking. Companies that seem great are awesome and can never possibly be "un-great". In essence there is a lesser comprehension of the risks associated and people buy and hold no matter where the prices go.
4. Informational: This is where the prices fail to reveal relevant information and then prices deviate from fundamental value.
There have been a lot of studies and experiments into bubbles (which are really interesting!). Simulations and such have turned up a lot of interesting things. Perhaps the least surprising was one done by a fellow named Vernon Smith who found that the fist time through study participants acted as if the bubble was a fad. The second time, although they sensed what was coming, it was a near rational bubble: they thought that they could get in, make some money and gt out before it burst.
EDIT: I just wanted to give credit where its due and note that I am using information that I first gleaned from a fellow named James Montier here, who is (IMHO) basically brilliant.