Economic and Financial Bubbles: Definition, Theory and Recent History

This thesis is concerned with the systematic analysis of economic bubbles. This is done through a review of the relevant literature, but specifically through the analysis of mathematical models attempting to explain bubble behaviour. Such a thorough and methodological examination of mathematical bubble models is, to date, missing from the literature. Two broad approaches to the study of bubbles are distinguished. The first sees bubbles as exogenous phenomenon. Here, economic bubbles can only be created from outside the efficient economic system. The second approach allows economic bubbles to emerge from within the complex economic system through varying levels of system stability. It is argued that among existing approaches there is a lack of a concise definition of economic bubbles. Beyond this, there are problems with methodology. One of the main issues identified throughout the literature but especially the mathematical models of economic bubbles is the assumption of equilibrium. It will be argued that the implied assumption of system stability leaves no room for bubble phenomena. And even if, in the case of the endogenous bubble literature, theoretically the equilibrium assumption is not needed to explain bubble behaviour, methodologically all examined models fall back on that notion. This then leaves the question of whether mathematical bubble models are appropriate when attempting to explain bubble episodes in real time. This thesis comes to the conclusion that, while an alternative paradigm to understand and explain bubble behaviour theoretically exists, methodologically, a paradigm shift away from calibrated mathematical models based in the natural sciences is needed if bubble episodes are to be explained in real time and real markets. The identification of varying levels of stability, employing real data, analysing economies in real time is proposed as a way forward in the explanation of bubbles.