Are we rational about bubbles?

Welcome! This blogger is from a developed city in a developing country, so he can use limited funds to explore unlimited speculation in an emerging market. Over the past few years, I've witnessed a lot of bubbles, and people are very good at pumping up prices on unfamiliar things, from imaginary Internet stocks with no real profit, to a certain flavour of wine, to a certain breed of dog from Tibet, and even old tea that tastes dizzy.

Figure 1: Tibetan Mastiff, this may be the most troublesome investment product for speculators.

In the classical literature of my country, there is a saying that may explain why everyone is crazy about chasing bubbles.

Jostling and joyous,

The whole world comes after profit.

Racing and rioting,

After profit the whole world goes!

                                                                 ------Shi Ji: Biographies Of Merchants

Trying to define a bubble or explain it is difficult. Adam Smith believed that bubbles were caused by "overtrading". N. W. Posthumus (1929) attributed this to the entry of non-professional buyers, facilitated by credit. Peter Garber advises that bubbles are best viewed as price movements that cannot be explained based on fundamentals.

Maureen O'Hara (2008) divided the bubble into four Perspectives, 

Rational traders, rational markets	Rational traders, irrational markets
Irrational traders, irrational markets	Irrational traders, rational markets

This brings most of the views on bubbles from history to the present.

It is true that most of the time, investment activities are the work of professionals, requiring sophisticated models and complex calculation formulas. In bubbles, due to various factors, it may be that the improvement of Marketability makes investment a game for all people to participate in. At this time, the structure of market participants has changed, almost everyone has become a trader, and a game involving the participation of all people has begun. As for the factors that determine these traders' orders, I believe that for them, the recommendations of classmates and friendly neighbours and the media's hype about buying specific stocks to get rich overnight are far more touching than analyzing the company's debt level.

When investment becomes everyone's entertainment, the proportion of non-professionals among traders will increase significantly. I think this will increase the irrational component of the market index (from the perspective of financial professionals), or in other words, it will be more in line with the behaviour
of the public. John M. Griffin & Amin Shams (2020) proposed that many bubbles in history contained misinformation, false accounting, price manipulation, collision, and fraud, often in sophisticated forms. These facts significantly increased the public's desire to buy at the time. Until everyone places a buy order, the market loses momentum.

Figure 2: The Shanghai Composite Index is closely related to the number of new accounts opened by investors

Defining the bubble itself is difficult. A bubble is when asset prices rise to surprising levels in a short period of time and then fall to surprising levels in a short period of time, this is caused by a large number of traders with different ideas. To analyze the personal behaviour of traders from a polite point of view is very difficult.

Figure 3: Tesla price history, Can we say there is a bubble?

What about rationality itself? I believe if you find any people on street, nearly all of them admit that they have rational elements, more or less. In fact, the criteria for judging rationality vary from person to person.

Suppose a student who failed the IELTS test many times.

To his classmates or strangers, he is irrational:

It is a waste of money and irrational for him to spend more than £3000 on  IELTS exams because his previous grade has proved he is stupid.  

For other part of his classmates and his parents, he is rational:

He only needs to succeed once, then he can study abroad and then have a decent job with a high salary, which is very rational.

Figure 4: it's a frustrating fact

Choosing an appropriate standard is difficult, which means the research on bubbles and rationality is hard to go deeper. Some experts even thought that no bubbles have ever existed. This leads me to a suggestion. In bubbles, everyone is rational from their own point of view but irrational from some people's point of view. So everyone made bets based on what they believed and the market reacted to the bets. History is created by all people. Might be something like when you grow up and find out you were stupid when young but don't think so at that time.