Definition
Per Kenton (2025), an economic bubble is the fast expansion of asset prices due to speculative behaviour, and/or decisions based on emotion (animal spirits) rather than on solid analysis. Both result in prices going to a point that is uneconomical, a price that does not justify a companies fundamentals. An economic bubble is then followed by a sharp contraction.
The Process of an Economic Bubble
Per Kenton (2025), the process goes as follows:
1. Displacement: investors notice a new trend, new product, technology, or low interest rates
2. Boom: Prices begin to rise and demand increases (FOMO in the markets).
3. Euphoria: asset prices soar, and investors abandon caution
4. Profit Taking: those who can spot a bubble can take profit by selling their positions
5. Panic: asset prices reverse and fall.
History - US Housing Bubble
As said by Kenton (2025), in the mid 2000s, banks lowered borrowing requirements and interest rates. New homeowners now had the possibility to get a mortgage and own a home. These homeowners were extra lucky because adjustable rate mortgages were on the table at the time, popular for their low introductory rates. Many people began buying homes, some even flipped them for profit. However, later on, interest rates rose, so for homeowners on adjustable rate mortgages, they suddenly had much higher borrowing costs. Home values fell, triggering a sell off in mortgage backed securities. There were millions in mortgage defaults.
Works Cited
Majaski, Christina. “Definition and Analysis of Fundamentals in Business.” Investopedia, 2019, www.investopedia.com/terms/f/fundamentals.asp.
Kenton, Will. “What Is an Economic Bubble and How Does It Work, with Examples.” Investopedia, 3 Apr. 2022, www.investopedia.com/terms/b/bubble.asp .
