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While many works have been done on individual economic, market, and asset price bubbles, or similar events from specific periods, most of these studies are centered around explorations of bubbles in a certain period or around particular events, and they do not provide us with an estimation regarding the average length or duration of a bubble.
Market participants may sense a bubble in specific areas; for example, some people believe that the meteoric rise of cryptocurrencies is irrational as they hold no intrinsic value; others hold a similar opinion about non-fungible tokens (NFTs) and other emergent ‘assets,’ as some call them.
But, after what duration of time can we dispel the apprehension that an elevated price of a specific asset, instrument, or even heightened level of economic activity is not an irrational boom; i.e., how long does a bubble last, and how long does an asset, etc., has to stay elevated to not be considered a bubble.
While, theoretically, as such price booms essentially are ‘irrational, or sanguine price upsurges,’ we can have a perpetual boom in an asset(s) price, as market participants can supposedly continue to act irrationally, we should, nonetheless, conduct a retrospective analysis to evaluate the average age of such phenomena.
To that end, this report analyses the average age of a market bubble, utilizing data from the eight most prominent such events in history. The report also calculates a confidence interval regarding the age of such price irrational price upsurges.
Such events from the 17th to 21st century have been examined for this analysis. Events of Tulipmania, the South Seas, Mississippi Company, the Bull market of the roaring ’20s, Japan 1980s, the Dotcom crash, and the housing price crash are examined for this investigation.
So, what does the data reveal?
Data from the eight most prominent such events in history reveals that an economic, asset, market bubble lasts for about 5.6 years or about 67.5 months. 98% confidence interval indicates a range of 3.1 years to 8.15 years. Thus, as per the data, there is a 98% probability that a bubble should have an age of 5.3 years ± 2.53 years.
Data & calculations:
Significance and application
Many investors that may be examining a price upsurge that, to them, doesn’t seem compatible with the fundamental or intrinsic value of the asset in question, can use the insights provided in this report as a quick rule of thumb that can indicate that they may be overlooking some factors of intrinsic value in their calculation or assessment of an asset, if they believe it is overvalued.
An example is provided below:
How can we know that bitcoin and cryptocurrencies are not a bubble?
An investor may hold a view that cryptos do not have any fundamental or absolute value, and thus, be persuaded by the argument that elevated crypto prices are an irrational upsurge in prices and, hence, divorced from reality.
But how can she test her assumption with a quick rule of thumb? Using the insights provided in this report, she may rethink her assumptions.
For example, understanding that 98% of bubbles, as per historical data, should have an age of 3.1 years to 8.15 years, and knowing that bitcoin, created in 2009, is already more than a decade old, she should recognize that as it ages more and more, yet still commands high prices, albeit, with very high price fluctuations and risk, it is becoming more and more difficult to dismiss the rise of crypto as a price upsurge driven by greed which is divorced from reality.
She may have to rethink her fundamental analysis, probe other factors that may be supporting cryptocurrencies’ intrinsic value (see our viewpoint: Why Is Bitcoin/Crypto Valuable if It Has No Intrinsic Value and It Is Not Really a Currency?) As explained in the linked report, investors may be using it for objectives that others may not consider a core value/purposes vector of BTC.
Final words of caution
While the insights provided in this report are based on historical data, and hence a reflection of past events, one should always remain skeptical and vigilant. As per the data, there is a high probability that bubbles in the future should follow timelines in the past, nonetheless, there can always be individual episodes that are shorter or longer than the data, and there is a 2% probability of that occurring, a possibility that shouldn’t be overlooked, therefore.
Another important point worth noting is that as financial instruments increase in complexity, or as new financial instruments are created, the probability of irrational price upsurges, detached from reality and fundamental value, rises. The lessons from the South Seas company & the U.S. housing market crash support this viewpoint, as in both instances, the creation of new instruments/’assets’ is argued to be a contributing cause.
In the future, if newer instruments or more novel ‘assets’ are created that, for whatever reason, market participants cannot value efficiently, the probability of long-term irrational price rises that are sustained beyond the 8+ years mark would rise. Therefore, investors should understand that insights provided in this report should be used as an indicator, not an absolute law. In-depth scrutiny and analysis of individual events, coupled with data insights, such as presented in this report, should provide better results.
References
Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds, ed. Martin S. Fridson (New York: John Wiley & Sons, 1996) 115.
Edward Chancellor, Devil Take the Hindmost: A History of Financial Speculation. (New York: Penguin, 1999).
Eileen Glanton, "Seventy Years After Black Tuesday, A Look Back" Associated Press, October 27, 1999.
U.S. State Department, "Country Background Note: Japan," September 2001
