What are losses before disposal of an asset?

Why are speculative asset bubbles bad?  What should we do about them?

• By what mechanism do asset bubbles cause social welfare losses (assuming arguendo that bubbles exist and are socially costly)?  Is it merely (or predominantly) because asset bubbles misallocate capital to the speculative asset class?  Or, rather, is it (also significantly) due to a recursive effect of volatility on "investor confidence"--that is, investors as a class irrationally overreacting to a visible, salient event like the bursting of an asset bubble? If the former (i.e., misallocation) explanation dominates, does this imply that it is the *inflation* of asset bubbles, rather than their *bursting*, that is socially costly?  If a regulator could reliably identify bubbles and engineer their controlled deflation (and by so intervening avoid a sudden burst), what social costs would be avoided by this scheme?  If capital misallocation is the main mechanism by which bubbles are costly, what role (if any) does the secondary capital market play in this process?  What role does (or should) prudential regulation (as opposed to anti-fraud and disclosure-based regulation) play in preventing bubbles from forming or in slowing/halting their inflation?

• Answer:

  Asset bubble can be defined as sustained increase for a very long period of time. But it is very difficult to characterize that it is an asset bubble and more so a speculative asset bubble. The 'feel good' factor that accompanies a speculative asset bubble makes it all the more difficult to accept it in the first place. The way a bubble bursts, a speculative asset bubble brings about destruction and contagious consequences to all other asset classes and to the larger economy, even remotely connected with an asset bubble. Various studies have been made to determine whether, at a particular point of time, whether it is an asset bubble. For an instance, 'margin debt' is said to be at all time high at present in US stock markets. Derivatives positions is said to be the order of $200 trillions for all financial markets together. Any attempt, to regulate an asset bubble will be hugely unwelcome measure ,as it is a market intervention and also can potentially result in a bubble burst. Increasing prudential norms, or increasing margins can be attempted.