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Bridge over ocean
1 March 1998 Financial Analysts Journal Volume 54, Issue 2

Bulls, Bears, and Market Bubbles

  1. Jack Treynor

According to some finance scholars, a securities market that does not exhibit a random walk cannot be rational. They point out that for a rational investor, changes in his or her expectations are entirely a surprise. The same is true for the consensus when investors share the same expectation. In real markets, however, investors disagree, and the equilibrium level reflects their wealth, as well as their expectations. When, for example, news raises the market level, the market rewards the bulls and penalizes the bears, leaving the bulls with more wealth, hence greater market impact, and the bears with less. The wealth shift causes an additional change in the equilibrium level and a further wealth shift. If investors' disagreement is large enough, the second change in equilibrium price can be bigger than the first and the third bigger than the second. Rational behavior by individual investors can cause a market bubble.

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