Question

What is the difference between a Ponzi scheme and an asset price bubble? The fact that risk and uncertainty are experienced differently might matter in times of financial crisis. Discuss

Answer 1

Difference between a Ponzi scheme and an Asset price Bubble :

A Ponzi scheme is a fraud scheme, in which they lure people into making investments promising them with high rates of return. The earlier participants are receiving high rate of interest with the money invested by the participants entering into the scheme later. This scheme, in order to sustain has to grow large, otherwise the earlier participants will not be paid their interest.In a Ponzi scheme , the risk and uncertainty is the underlying fraud in the mind of the people.

Asset price bubble, is not necessarily a fraud, the developments taking place is open to all. Bubbles involve actual investments into financial asset , people keep investing large amounts in the financial asset, till the prices reach a peak. Once price has reached its peak, while some speculators can make out that this is an asset bubble, prices start to fall, panic sets in and the investors lose their money.

This is not necessarily a fraud, but lack of government regulations and misleading data provided by the ratings agencies instigate such asset bubbles.