Asset Price Bubbles

This reading, "Asset Price Bubbles." notes that speculative bubbles sometimes occur in asset markets and describes current research efforts that attempt to explain why bubbles occur and how they behave.

1. Define the following terms used in the reading:
   1. bubble
   2. economic fundamentals
   3. price-dividend ratio

2. What evidence of excess stock price volatility does Lansing present in Figure 1?
3. According to the efficient market hypothesis, what should the observed price of a stock represent? Why, as Lansing suggests, should a rational forecast of a variable be less volatile than the variable itself?
4. What is the distinction between irrational exuberance and rational speculation?
5. What do rational bubble models and near-rational bubble models have in common? What are the main differences between them? Why must rational bubbles always be positive? Why doesn’t the same limitation apply to near-rational bubbles?
6. What are the asset market implications of Keynes's comparison of the stock market to a beauty contest?

Source: "Asset Price Bubbles." Kevin J. Lansing, FRBSF Economic Letter No. 2007-32, Federal Reserve Bank of San Francisco, October 26, 2007.