Bubble Investing: Learning from History
History is important to the study of financial bubbles precisely because they are extremely rare events, but history can be misleading. The rarity of bubbles in the historical record makes the sample size for inference small. Restricting attention to crashes that followed a large increase in market level makes negative historical outcomes salient. In this paper I examine the frequency of large, sudden increases in market value in a broad panel data of world equity markets extending from the beginning of the 20th century. I find the probability of a crash conditional on a boom is only slightly higher than the unconditional probability. The chances that a market gave back it gains following a doubling in value are about 10%. In simple terms, bubbles are booms that went bad. Not all booms are bad.
The author thanks Elroy Dimson, Paul Marsh and Mike Staunton for the generous use of the DMS database and Michele Fratianni for providing the data on the Casa di San Giorgio. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.
- The great majority of booms during which market values doubled in a single year were not followed by crashes wiping out those gains...