In the late 1990 s, as information technology advanced...

In the late 1990 s, as information technology advanced rapidly and the Internet was widely developed, U.S. stock markets soared, peaking in early 2001 . Later that year, these markets began to unwind and then crashed, with many commentators identifying the previous few years as a "stock market bubble." How might it be possible for this episode to be a bubble but still adhere to the efficient market hypothesis?

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Key Concepts

Rational Bubbles

Rational bubble theory suggests that asset prices can deviate from fundamental values even when market participants are acting rationally. Investors might knowingly buy overvalued assets because they anticipate being able to sell them at an even higher price to someone else in the future. This behavior, coupled with limits to arbitrage, allows bubbles to form in markets that are otherwise efficient.

Efficient Market Hypothesis

This theory states that asset prices fully reflect all available information, meaning that future price movements can only be explained by new information. In an efficient market, it is assumed that investors act on all the data at their disposal, thereby making it very difficult to consistently outperform the market or find undervalued assets through analysis alone.

Asset Bubble

An asset bubble occurs when the market price of an asset significantly exceeds its intrinsic value, often driven by excessive market exuberance and speculative trading rather than fundamental value. Bubbles typically build up over time and can burst suddenly, leading to sharp corrections in market prices.

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