Presentation:

Topic: Bubbles and fools

Submitted to: Sir Dr. Younas Iqbal

Submitted by: Madiha Kanwal

Haseeb Waheed
Hafiz Sameer
Financial crisis of 2007-2008

A growing chorus has argued that

policymaker ought to act more
aggressively to rein in bubbles.

Conventional wisdom among

policymaker cautioned against
acting on suspected bubbles.
 Two reason for cautioned:

Asset price is increasing & difficult to

access that the prices likely to
remain high or not.

Many of the available tools for

reining in asset prices i.e. raising
nominal short-term interest rates
impact economic activity more
broadly.
 What is Bubble?

A time when asset price deviate

from its Natural price.
OR
A time when asset price rise to
quickly and suddenly collapse.
What happen when bubbles appear?

When bubble appears in the market,

many businesses overvalued their
underlying assets. As a result it
becomes difficult to calculate the
discounted cash flows.
 Speculative trading?

Agents trade assets not because

they expect mutually beneficial gains
for trading with others, but because
they expect to earn profit at expense
of others.
 As its difficult to create a model
that give rise to the bubble. Why?

Because people will naturally be

reluctant to pay more for an asset
than the value of dividend it
generates.
 Bubbles & Risk Shifting:

Agents buy risky asset and borrow

against these assets. Thats the way
they can shift loss on creditors by
defaulting.
 Greater-Fool Theory:

Agent are willing to pay more for an

asset. They anticipate they might be
able to sell it to someone else for
higher price. Such explanation known
as Greater-Fool Theory. Because they
somehow involve in speculative
trading.
 Aim of the paper is to construct a
model where such bubbles can be
daunting. For this, we have to
assume that traders are rational and
understand the underlying
environment they face.
 Greater-Fool Theories are a fools
errand:

In 1982, Tirole derived conditions under

which greater-fool theory ruled out.
1- Number of potential traders are finite.
2- Traders are rational and have common
knowledge.
3- Traders start out with prior common
beliefs about the environment they face.
4- Resources are allocated efficiently prior to
any trade taking place.
 Asymmetric information:

Sometimes it referred to as
information failure. This normally
manifests itself when the seller of a
good or service has greater
knowledge than the buyer, although
the opposite is also possible. Almost
all economic transactions involve
asymmetric information.
Bubbles & Asymmetric information:

Due to asymmetric information seller

try to do speculative trade and want
to use greater-fool theory as well but
the scenario may occur in opposite
direction from the side of buyer as
well.
 Conclusion:
This article described the literature on
greater-fool theories of bubbles, that is,
theories in which agents are willing to buy
assets they know to be overvalued because
they believe they can profit from selling the
assets to others. The idea behind this theory
is intuitive and seems to capture aspects of
what often happens during real episodes that
are suspected to be bubbles. This theory can
also capture the unsustainable nature of a
bubble that makes asset bubbles a concern
for policymakers. And yet it turns out to be a
surprisingly difficult theory to model and
Thank
you..