By E. Porras
Asset bubbles and contagion have had a profound impact at the monetary markets after the monetary and sovereign debt crises. This booklet takes a quantitative method of analyzing those phenomena and may entice practitioners who have to comprehend the repercussions of those occasions on buying and selling exchanges and the markets.
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Extra info for Bubbles and Contagion in Financial Markets, Volume 1: An Integrative View
44 However, by early 2007, it was already clear that home prices were falling, mortgage originators faltering, and a growing number of families could no longer afford their mortgage payments. 46 Inevitably, startled investors sent prices plummeting, while hedge funds facing margin calls began to sell at distressed prices, and banks began to write down the value of their holdings by tens of billions of dollars. In addition, several securitization markets were brought to a halt after June. For example, $75 billion in subprime securitizations were issued in the second quarter of 2007.
The bubble expands through the process of price inﬂation, and then bursts upon the realization that the rate in the price increase is no longer tenable. 2:81 a. Stealth. During the stealth phase, informed market participants discover an opportunity for important wealth creation. Risk is attached to the opportunity as the future growth assumption is so far a hypothesis. At this time, it is sector experts who get into the market in a discreet manner and who, as prices gradually increase, purchase larger stakes in the business.
Given the spectacular returns produced during the initial phases of bubble growth, suppliers misallocate their resources and, while unable to cope with demand during the initial phase, they over-estimate future demand. The ensuing excess capacity results in a waste of capital, particularly worrisome in capital-intensive sectors, and eventually destroys know-how, production, and distribution capabilities. The reason is that suppliers have already scaled up their operations and, cutting production, in view of demand destruction, barely results in variable cost Introduction to Bubbles and Contagion 29 reduction.
Bubbles and Contagion in Financial Markets, Volume 1: An Integrative View by E. Porras