By Chen Daofu, Institute for Finance Research, Development Research Center of the State Council (DRC)

Report No 164, 2014 (Total 4663)

Abstract:

From the perspective of normal fluctuations and structural adjustment of the economy, this paper redefines asset bubbles as a self-circulating system in some parts of the national economy, based on "unreal" factors. It is out of tune with the higher-level system, but lasts for a long period of time. The bubbles continue to accumulate in the same direction, but will be proved wrong in terms of resource allocation. The causes of asset bubbles are: first, a continued cognitive bias, including the use of defective indicators, misjudgment of the economic situation due to abnormal mood or faith, and a lack of transparent innovation and information; second, a mechanism resulting from a persistent bias, such as the twisty incentive and constraint mechanism and an invalid mechanism induced by negative feedback. This paper classifies the typical asset bubbles evolution under five stages including survival of the fittest, bad money driving out good, a Ponzi scheme, stagnation and reversion and self-collapse and suggests some key factors to prevent asset bubbles from evolving in a wrong direction at different stages.