Taming Global Village Risk II: Understanding and Mitigating Bubbles
Posted: 30 Apr 2008 Last revised: 8 Nov 2010
Date Written: May 27, 2008
Asset bubbles and their subsequent bursts have been a part of capital markets since modern capital markets began to evolve some 300 years ago. Although each bubble environment certainly has its own distinguishing characteristics, certain common elements persist as key ingredients in bubbles over time: financial innovation, the emotions and psychology of investors, and leverage. This paper explores how these features present themselves in market bubbles and ensuing market disruptions and offers some suggestions for improving future risk management. Among the recommendations, we suggest a flexible oversight framework with a goal to identify and contain areas of excessive economic risk.
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