Definition
“Irrational exuberance” is a term coined by former Federal Reserve Chairman Alan Greenspan during a speech delivered on December 5, 1996. The term describes a market sentiment where investor enthusiasm drives asset prices to levels that are not supported by fundamentals, potentially leading to market bubbles and eventual crashes. Greenspan’s reference was pivotal in highlighting the dangers posed by speculative bubbles in financial markets.
Examples
- Dot-com Bubble (Late 1990s to Early 2000s): This period was characterized by skyrocketing technology stock prices, which were inflated by expectations of revolutionary impacts from internet technologies, without corresponding revenue or profit proofs from many companies.
- Housing Bubble (Mid-2000s): Residential property values soared rapidly due to easy credit, high investor demand, and speculative involvement, eventually leading to the 2008 financial crisis when the bubble burst.
Frequently Asked Questions (FAQ)
Q: What did Alan Greenspan mean by “irrational exuberance”? A: Greenspan used the term to caution against unwarranted and speculative increases in asset prices, suggesting that such scenarios might lead to significant market corrections or crashes.
Q: How does irrational exuberance affect the economy? A: It can lead to the creation of economic bubbles. Once these bubbles burst, it often results in severe market downturns, financial instability, and potentially widespread economic recessions.
Q: Can irrational exuberance be prevented? A: While challenging to prevent entirely, regulatory measures, stringent financial oversight, and promoting investor education about market fundamentals can help mitigate its impacts.
Q: What are the signs of irrational exuberance in the market? A: Unusually high valuation multiples, rapid inflows of speculative capital, and pervasive investor optimism typically unsupported by fundamental economic indicators are signs.
Related Terms
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Market Bubble: A situation in which asset prices significantly exceed their intrinsic value due to widespread speculative fervor.
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Speculative Bubble: An economic cycle characterized by the rapid escalation of market value, particularly in the price of assets, followed by a contraction.
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Asset Valuation: The process of determining the worth of an asset or a company based on earnings, capital, and market sentiment.
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Carties: Forums or markets characterized by unstable pricing due to speculative trading, often prone to bubble and burst cycles.
Online References
- Federal Reserve Board - For policy statements and historical speech archives.
- Investopedia Article on Irrational Exuberance
- Wikipedia Entry on Alan Greenspan
Suggested Books for Further Studies
- “Irrational Exuberance” by Robert J. Shiller - Comprehensive examination of market bubbles and investor psychology.
- “Manias, Panics, and Crashes: A History of Financial Crises” by Charles P. Kindleberger and Robert Z. Aliber - Explores the repetitive nature of market manias.
- “The Intelligent Investor” by Benjamin Graham - Insights on disciplined investing and avoiding speculative pitfalls.
Fundamentals of Irrational Exuberance: Finance Basics Quiz
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