Can You Explain The Concept Of Bubbles And Crashes Given By Burton Malkiel?

The history of finance is one of the most exciting and sobering parts of economics. As Burton Malkiel writes in his survey of bubbles, panics, and the madness of crowds, "Greed run amok has been an essential feature of every spectacular boom in history.

Investors are sometimes divided into those who invest on firm foundations and those who try to outguess the market psychology. The firm foundation approach holds that assets should be valued on the basis of their intrinsic value. For common stocks, the intrinsic value is the expected present value of the dividends. If a stock has a constant dividend of $2 per year and the appropriate interest rate to discount dividends is 5 percent, the intrinsic value would be $2/. 05 = $40 per share. The firm foundation approach is the slow but safe way of getting rich.

History 8is marked by bubbles in which speculative prices were driven up far beyond their intrinsic value. In seventeenth century Holland, a tulip mania drove tulip prices to levels higher than the price of a house. In the eighteenth century, the stock of the South Sea Company rose to fantastic levels on empty promises that the firm would enrich its stockholders. In more recent times, similar bubbles have been found in biotechnology, Japanese land, emerging markets, and a vacuum cleaning company called ZZZZ Best, which turned out to have profited from laundering money for the Mafia.