9Three Australian Asset-price Bubbles
2. What is a Bubble?
One of the more common things said of bubbles is that ‘you know one whenyou see one’. Unfortunately this means different things to different people. Someeconomists do not believe that there have been any asset market bubbles – merelyexamples of unrealised expectations.
Others even suggest that periods of ‘irrationaldespondency’ are more common than periods of ‘irrational exuberance’.
Thereare numerous academic papers discussing whether certain episodes are, or are not,bubbles and there is no consensus in the literature.
To answer the question posed I begin with a brief presentation of four famousbubbles; this serves to outline the data underlying this discussion. Section 2.2 thendiscusses previous academic writing on bubbles and their classi
cation of variousbubble episodes. I argue that most of these papers do not provide a satisfactoryde
nition of bubbles. Instead, I propose a slightly different approach to identifyingbubbles and provide a de
nition of bubbles based on that approach in Section 2.3. Thisde
nition forms the basis for calling the episodes selected in this paper ‘bubbles’.
2.1 Four famous bubbles
I start my de
nition using the following events: the South Sea bubble, railwayspeculation in the 19
century, the US stock market in 1929, and the Internet bubbleon the NASDAQ. There have been many more speculative bubbles throughout history.Kindleberger (2000), Mackay (1980) and Chancellor (1999) provide informativereading for those interested in more details and examples. The examples presentedhere are intended to provide a representative rather than exhaustive sample.
2.1.1 The South Sea bubble
The South Sea bubble primarily involved trading in the shares of the South SeaCompany in 1720. This company was formed in 1711 by a group of merchants andgiven a monopoly on British trade with the South Seas – Spain’s South Americancolonies – in exchange for taking over some British government debt. A problemwas that Spain was unwilling to allow much British trade.
Thus, the actual tradeinvolved in the company’s activities was relatively limited. Rumours of tradeagreements with the King of Spain helped fuel some speculation. The bubble was,however, based around a purely
2. See Garber (1990).3. See Siegel (2003).4. Section 2.2 provides more details about the relevant literature.5. See Mackay (1980, pp 46–88) and Chancellor (1999, pp 58–95) for further details.6. The only trade allowed was to provide slaves to the Spanish colonies and one general trade shipper year of a restricted tonnage and cargo value from which the King of Spain, in any case, tooka substantial cut of the pro