Question

. Explain the term irrational exuberance, and give an application of how it works

Answer 1

Irrational exuberance is a term which is used to define the excitement of the investors towards a particular asset and because of the price of that assets increases and reach the level which is not sustainable technically and fundamentally.

This is a problem because it give rise to asset bubbles due to this sharp rise in price.When time comes that this bubble burst, there is a domino effect in the market and everyone holding the asset want to sell that and save its money but there are no buyers in the market.

This was the term used by Alan Greenspan, Federal chairman, during the time of dot com bubble in 1990s

There are various examples for that like dot com bubble in 1990s, 2008 housing crisis, surge in gold prices in 2011, boom in oil prices in 2014 and latest is bitcoin price rise.

All of these work under same principal. Investors become overly bullish for that particular asset at that particular time and they only want to earn more and more money and keep ignoring the negative effects of that. And once that turn comes, there is a panic situation and crisis arise.

For example, during housing booms, banks were giving housing loans to people without any credit check because they were certain that if the borrower default, they will recover the amount from the collateral i.e. house itself price of which they believe will keep on increasing. This become bubble and when it burst, they was crisis in the whole world.

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