Analysis of Stock Market Bubble: Causes, Stages, and Participants

This report provides a comprehensive analysis of stock market bubbles, examining their formation, causes, and the various stages they undergo. It delves into the factors that contribute to the creation of speculative bubbles, including market participants such as investors, brokers, and companies, and how their behaviors and actions influence market dynamics. The report explores the role of rumors, insider trading, speculation, and government policies in shaping these bubbles. Furthermore, it identifies factors that can trigger transitions between different stages of a bubble, such as the Brexit policy and the Coronavirus pandemic. The report also discusses the impact of herding behavior on market movements and provides a detailed overview of the current boom stage of the bubble in the stock market, highlighting potential future developments and risks. This analysis aims to provide a detailed understanding of financial market behavior.

FINANCE

Table of Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY...................................................................................................................................3
Financial Bubble and its causes..................................................................................................3
Causes.........................................................................................................................................3
Theory of Bubbles.......................................................................................................................3
Evidence of Bubble.....................................................................................................................6
Stage of the bubble in stock market............................................................................................7
Financial Markets and their participants.....................................................................................8
Factors that causes the movement of bubble from one stage to another...................................10
CONCLUSION..............................................................................................................................12
REFERENCES..............................................................................................................................13

INTRODUCTION
This project shall be highlighting the concept of formation of the stock market
speculative bubble. The speculative bubble in the stock market forms when there is an unviable
rise in the prices of the stocks, asset classes of specific category as against its fundamental value.
The report shall also be defining the various stages of the speculative bubble that the stock
market can enter. It shall also be reflecting the various participants in the stock market who are
responsible for the formation of such bubble. The rumours, insider trading practices, speculation
and the policies of the government are some reasons why participants react and then lead to
forming such speculative bubble which is cannot be predicted. Lastly it shall be disclosing the
factors that shall lead the stock market move from one stage to another and how the economy is
being affected by all these movements.
MAIN BODY
Financial Bubble and its causes
Financial Bubble refers to increase in prices of the financial assets that leads to the price
tag which does not reflect the actual value of the asset. In this bubble the investors bids up prices
beyond the economic reality as the price rise becomes self-sustaining. Later or sooner higher
price becomes unsustainable and it tends to fall dramatically until assets are valued at or below
the true worth.
Causes
The financial bubble is caused when the price of particular items rises more higher above
the real value of the items. The bubbles are created in number of markets which are housing,
internal stocks, tulip bulbs, gold and baseball cards. It is caused by the rapid escalation of the
market value mainly in prices. There is surge in the prices of the assets which are driven by the
exuberant market behaviour. The stock market is in bubble as the prices of the stocks are greatly
exceeding its intrinsic value.
Theory of Bubbles
The main components of the bubble which are price and valuations. However, these are
not considered in the inflation stage. The below graph shows the price bubbles in market and
these were dismissed under the inflation.

The valuations of these stocks are also dismissed with the new metrics and made endeavour into
the earning yields (). Valuations have significant impact over the expected returns.

Investors play a significant role in framing the bubble as they represent herding
behaviour which are reflected in the prices and valuations of the stocks (Stock Market Bubble,
2021). Bubbles could exist even in cases where fundamental and valuations are arguing
otherwise. The below chart provides long term valuation of S&P 500 from 1871.
It is noticed that except for 1929, 2000 & 2007 and other crash in market occurred with
the valuation at the levels which are Lower than current level. It could be seen in table from the
Tavi Costa at the Crescat Capital markets that are trading currently in top decile of the valuations
at many levels.

Secondly all the market crashes that resulted from preceding bubble are result of the things
which are unrelated to the valuation level. The catalysts range from the liquidity issues to the
government actions, mistakes in monitory policy, inflationary spikes or recessions (Stock Market
Bubble, 2021). These events trigger which started reversion of the sentiments by investors.
Evidence of Bubble
Deep analysis is not required to find evidence about psychology driving current stock
market bubble. There are many interviews which show that they have fear to miss out or have no
alternative. There are number of evidence for market bubble in action of investors. They are
exhibiting currently all behaviours associated with the prior stock market bubble, from
aggressive equity's allocation to the risk leverage.
Presently investors hold highest level of the equities on record.

They also leveraging investment risks carrying highest level of the call options in the history.
Investors are doing it as they are highly confident that market will not be improved or corrected.
Stage of the bubble in stock market
The market Bubble is currently in the boom stage as the prices of the capital assets are
rising continuously. The S&P 500 Index is around 15% high for year. It is evaluated through
various studies that market is nearing the levels which were seen last in the 2000, when dot com
bubble started to burst. IPO refers to companies issuing new shares to public having busiest years
in the two decades and even many of firms are unprofitable. Currently financial market is
booming stage as the investors are increasing their investments in IPOs highly.
It is stated as booming stage as the prices are rising in the stock markets. They are seeing
considerable rise in the prices which were seen in the previous bubble times (Stock Market
Bubble, 2021). However, prices have not yet reached it all time high. It will continue to rise for
coming years till it reaches the peak high prices.
Since the market is expected to rise these days they are ascertained with much prudence.
So the investor thinks to earn returns from the hiked price and are taking the steps for earning the
returns (FTSE 100 shares: is the stock market bubble set to burst? 2021). The increase in
investments are creating the philosophy for increasing the investments in stock prices. Seeing the
rising prices people are investing in the IPO's even in the unprofitable firms.

Financial Markets and their participants
Participant of stock market play an important role in formation of bubble. Participants
like investors, regulatory body, companies, workers, brokers etc. there are several players that
contribute in fluctuation of shares in stock. As every stage of market bubble created when
unusual activities in trading act take place. There are various ways through participants get
influenced by articles and news. In new predictions are given and false statement. Intra trading
and changes in company policies also take place in changing decisions regarding investment. All
this are reasons that contestant of bubble contributes in making bubble or changing stage of
bubble.
The stock market behaviour is generally according to the demand and supply forces
which are affected by the current performance and position of the company and also the future
plans and growth prospects that the company may be achieving (Ghosh and Kanjilal, 2016).
Mostly the movements of the market can be predicted as the herd behaviour shall be for the
company that can provide better returns and so the favourable movement for such company shall
take place. But sometimes due to some reasons like insider trading, rumours and speculations
etc. the market becomes unpredictable and enters a speculative bubble (Hung and Ma, 2017).
The participants of the stock market are responsible for the formation of such bubble:-
Investors- The investors or the shareholders are the one who owns shares of a public listed
company and with the ownership they are privileged with certain rights like right to vote,

exercise powers and the right to receive the dividends. These investors invest in the
company which shall give them maximum returns and have future growth prospects. But
sometimes the investors react upon the rumours in the market which may or may not be true
leading to speculation in the market (Sun and et.al. 2020). Due to the psychology created by
the brokers and third parties’ investors for getting returns and increase in their wealth are
continuous increasing their investments.
Brokers- Brokers are the middlemen or the agents who buy and sell securities at the stock
exchange. They are provided licence by the stock exchange to carry out these activities.
They also influence the market by their opinions which may be based on the rumours or the
insider trading practices. They advise the investors or are sometimes given the rights to
decide themselves which shall change the buying and selling decisions of the investor. This
can cause an unnecessary hike in the prices which is far from the fundamental values of the
asset. Brokers are creating the psychology for getting higher returns that leading the
companies and people to invest in the shares. They increase the demand for shares
influencing the buyers to get higher returns. Increase in demand creates raises the prices
even of unprofitable and underperforming companies.
Companies- Companies also form important part of the stock exchange as their shares are being
traded in the stock market. With the help of this they arrange capital for conducting their
business operations smoothly. The trading shall be in response to the profitability and the
position of the company. They can be responsible for creating a speculative bubble by
providing false information regarding the plans of the company in future or making some
big innovation.
Regulators- The regulators are the ones who formulate various laws and policies to avoid the
fraudulent activities in the stock market. Many a times these laws also create complexities
which lead to a sudden movement in the market which remains unpredictable by those who
forecast the market. These movements are in compliance with the regulations, but then they
impact the behaviour of the stock market. The monetary polcies and fiscal policies are not
stable and leading the investors to purchase shares in diversified portfolio. The interest rates
are low causing people to invest by borrowings. Also the monetary policies have declined
the inflation rates that are causing the people to get returns through stock market and this is

forming bubble. Government is proposing policies for reducing the debts which is causing
decline in the inflation rate and people to shift towards stock markets.
Factors that causes the movement of bubble from one stage to another
There are some prominent factors that shall lead to the movements in the stock market
leading it to move from one stage of the bubble to another. At some or the other time all the
stages of the bubble are covered and then it matches the fundamental price, to end the
speculative bubble in the market. Currently if the stock market is in profit taking stage then it can
move to other stages depending on the factors and their simultaneous impact on the behaviour of
the participants. If closely company declares its plan then it can enter boom stage (Chatzis and
et.al. 2018). If intensive selling takes place to assume profits and the company does not come up
with better strategies than the bubble shall burst at the peak or shall take reverse and enter panic
stage. Some factors that can lead to movement from one stage to another are-
BREXIT Policy- Due to the Brexit policy there are lot of uncertainties in the market about the
trade agreement that is to be signed. This can play an important role in the stock market and its
behaviour. With the exit from European union many companies can face severe issues related to
market access, trade barriers, imposition of taxes and the job stability. This will lead to negative

impact on the company and decrease the value of its shares, impacting the stock market to move
into the panic stage.
Coronavirus- Breakdown of the pandemic currently can also prove to be an essential factor
influencing the stock market behaviour. Due to the lock-down for several months the
profitability and future growth prospects got affected ultimately laying down the value of the
business. The survival of many companies was threatened which lead to the stock market
movement from boom to the profit taking stage.
Herding Behaviour- This is one of the most prominent factors that shall cause the stock market
to enter various stages of the bubble. The participants of the stock market feels that following
majority is safe as everyone cant be wrong. Or they influence their decision with banks and
financial experts and believe their investment shall prove to be good and maximize the returns.
Short term decisions- Majorly the decision-making and the choice of investments is made
keeping short term in mind rather than planning for the long term profitability and the
sustainability which leads to undesirable movements in the market.
Irrational Exuberance- This is one of the factors where the decisions regarding where to invest
are taken on the basis of psychological pressures (Litimi, BenSaïda and Bouraoui, 2016). These
pressures shall be motivating the investors to purchase the shares by completely ignoring the
fundamental value of the asset and the prospective returns that can be generated.
Past Expectations- Majority of times the past expectations overshadow the future events. Based
on the experiences of how market reacts to particular situation, the same is expected to happen in
the future. The decisions are influenced by this belief which shall cause speculative traits inn the
market.
Global Imbalances- Sometimes the imbalances that are there globally also impacts the economy
of a particular country, which ultimately can be seen in respect of its market forces. The inflows
of currencies, trading globally, political environment of various countries, war situations etc. are
impacting the market (Brunnermeier, 2016).
Lack of knowledge- The lack of knowledge and understandings of the stock market is also one
of the reasons that leads to uncertainties and unpredictability in the market. For these nowadays
experts are present who properly manage the wealth of the person.

Cognitive Dissonance- Some investors filter out or ignore the important aspects of the news and
focus on the parts of the information that can satisfy their belief. And the behaviour is also
accordingly identified (Recognizing a Speculative Bubble, 2021).
Monetary policy- The monetary policies is also the factor that has a direct impact on the
purchase and sell decisions. The interest rates and the money in circulation decides the
investment decisions of the company. They can be held responsible for the speculation that takes
place within the stock market and influence its prices.
CONCLUSION
The project mainly concentrates on the formation of speculative bubble in the stock
market and the various stages it passes through in accordance with the behaviour of its
participants. It shows the detailed analysis of the various stages of the price bubble, its
characteristics and what leads the stock market to enter a particular stage. It also describes that
the economy and its stock market currently is in the phase of profit taking wherein investors are
liquidating their assets. Apart from this it shall explain the participants of the financial market
and the role they play to unnecessary hike the prices to assume benefit. Sometimes it can be
intentional in case of insider trading whereas rest of the times it is unintentional based on the
rumours. Further it enlists the factors contributing to the unpredictable movements of the market.