What can be explained by economics and what cannot be explained? 3

Today I want to continue with this topic and discuss how rational sophisticated investors can still create a bubble in the stock market. Let's talk about bank-run first. There is one explanation for bank-run that bank-run is caused by a black swan event when many individuals unintentionally take out their money out of their banks at the same time. This could also happen to the stock market. When many people unintentionally sell off their stocks at the same time, this will create a phenomena of bubble bursts that the stock market will fall sharply. This does not create a bubble but definitely creates a phenomena of a bubble burst. 

When we are talking about bubbles, there is always a difficulty of defining a bubble before a bubble bursts. For example, we cannot be certain about if there is a real bubble in the cybercurrency market. Moreover, because of the constraint of receiving and analyzing information, no one is certain if they actually know the fundamental of the stock market; therefore, it is normal for rational investors to misestimate the fundamental of their stocks. In addition, because of the uncertainty of the future, the stock prices in the future are always uncertain, they will be revised after resolution of uncertainty every period. Therefore, when a state with a very insignificant probability actually takes place, there will be a sharp price drop in the stock market. When this stock attracts lots of attention because it is less risky and generates good capital returns, such event takes place, it will influence a large amount of investors. When a large amount of investors suffer capital losses, their live standards might be impacted and they may need to liquidate some of their other assets, this will influence the entire stock market. This will also produce a phenomena of bubble burst. 

To conclude, we still cannot define a bubble before a bubble actually bursts. Since we only recognize a bubble after a bubble bursts, if we can see a similar pattern in the market as a bubble bursts, we can see that rational investors can still create such pattern in the stock market and we can refer this to what we usually call as a bubble.