Economic Theory and Asset Bubbles

In the late 1990s, there was a dramatic run-up in the stock prices of various publicly traded U.S. firms, particularly those specializing in information technology and its applications. A similar run-up occurred in housing prices in the early 2000s. These episodes have often been cited by pundits as examples of “asset price bubbles.” Implicit in this description is the notion that the rapid growth in the prices of the assets in question over such a short period suggests these assets were overvalued and thus at risk of a “correction,” or a sharp fall in price. In the case of the stock market, prices did in fact decline in 2000, with some indexes falling quite precipitously, including the NASDAQ-100. The slowdown in the growth of housing prices starting in the summer of 2006 has been offered by some as evidence of the beginning of a similar decline in the housing market.