What Contribution Can Behavioural Finance Make to the Explanation of Stock Market Bubbles and Crashes?
The occurrence of stock market bubbles and crashes is often cited as evidence against the efficient market hypothesis. It is argued that new information is rarely, if ever, capable of explaining the sudden and dramatic share price movements observed during bubbles and crashes. Samuelson (1998) distinguished between micro efficiency and macro efficiency. Samuelson took the view that major stock markets are micro efficient in the sense that stocks are (nearly) correctly priced relative to each other, whereas the stock markets are macro inefficient. Macro inefficiency means that prices, at the aggregate level, can deviate from fair values over time. Jung and Shiller (2002) concurred with Samuelson’s view and suggested that waves of over- and undervaluation occur for the aggregate market over time. Stock markets are seen as having some predictability in the aggregate and over the long run.
CHARACTERISTICS OF BUBBLES AND CRASHES
Bubbles and crashes have a history that goes back at least to the seventeenth century (MacKay 1852). Some writers have suggested that bubbles show common characteristics. Band (1989) said that market tops exhibited the following features:
1. Prices have risen dramatically.
2. Widespread rejection of the conventional methods of share valuation, and the emergence of new ‘theories’ to explain why share prices should be much higher than the conventional methods would indicate.
3. Proliferation of investment schemes offering very high returns very quickly.
4. Intense, and temporarily successful, speculation by uninformed investors.
5. Popular enthusiasm for leveraged (geared) investments.
6. Selling by corporate insiders, and other long-term investors.
7. Extremely high trading volume in shares.
Kindleberger (1989) and Kindleberger and Aliber (2005) argued that most bubbles and crashes have common characteristics. Bubbles feature large and rapid price increases, which result in share prices rising to unrealistically high levels. Bubbles
CHARACTERISTICS OF BUBBLES AND CRASHES
Bubbles and crashes have a history that goes back at least to the seventeenth century (MacKay 1852). Some writers have suggested that bubbles show common characteristics. Band (1989) said that market tops exhibited the following features:
1. Prices have risen dramatically.
2. Widespread rejection of the conventional methods of share valuation, and the emergence of new ‘theories’ to explain why share prices should be much higher than the conventional methods would indicate.
3. Proliferation of investment schemes offering very high returns very quickly.
4. Intense, and temporarily successful, speculation by uninformed investors.
5. Popular enthusiasm for leveraged (geared) investments.
6. Selling by corporate insiders, and other long-term investors.
7. Extremely high trading volume in shares.
Kindleberger (1989) and Kindleberger and Aliber (2005) argued that most bubbles and crashes have common characteristics. Bubbles feature large and rapid price increases, which result in share prices rising to unrealistically high levels. Bubbles