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Bubbles are rarer than you think

BUBBLES put the fun into financial history. Who can resist stories about Dutch tulips that were worth more than country estates or the floating of an “undertaking of great advantage but no one to know what it is”?

Ever since the financial crisis of 2007-08, economists have debated whether bubbles can be identified, or indeed stopped, before they can cause widespread damage. That is easier said than done: even tulipmania may have been caused by a quirk in the wording of contracts that meant speculators would, at worst, walk away with only a tiny loss.

For many investors, the more important question is whether it is possible to avoid being sucked into a bubble at the top, and suffering declines like the 80% drop experienced by the NASDAQ 100 index of technology stocks between March 2000 and August 2002. Two essays in a new book*, from the CFA Institute Research Foundation and the Cambridge Judge Business School, indicate just how difficult market timing can be.

The first, from William Goetzmann of Yale School of Management, looks at the history of 21 stockmarkets since 1900. Mr Goetzmann defines a bubble as a doubling in a…Continue reading

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