What is Asset Bubble ?

In accounting, an asset is a financial reserve. It could either be tangible or intangible, and it can be used by its owner to create value. In other words, assets reflect the worth of proprietorship that could be transformed into money (though money is also treated as an asset).

The financial worth of assets managed by a firm is documented in the balance sheet. Tangible assets can be categorized as current assets and fixed assets.

Current assets consist of inventory, accounts receivable, cash among others. Fixed assets include structures and machinery.

Intangible assets are not real resources, but they provide the firm a competitive advantage. For e.g., brand value, patents, trademark.

An asset bubble is defined as the process in which the value of shares or other assets increase significantly and at a constant rate that they surpass estimates supported by basics. It is probable that an unexpected crash could take place and at that stage the bubble would burst.

There are many reasons for an asset bubble including low-interest rates. Low rates result in an excess supply of money in the market. Investors can secure funds inexpensively, but they would not get high returns on bonds. Hence, they migrate to an alternate asset class.

An asset bubble could also be intensified by a supply scarcity under the scenario that investor confidence is low. Several recent asset bubbles are mainly due to demand-pull inflation. It is a type of inflation that is not correctly reflected in the Consumer Price Index (CPI).

Hence, financial decision makers do not pay attention to it, eventually it keeps increasing and bursts.

There are several ways an investor could safeguard from an asset bubble. The trademark of an asset bubble is unreasonable eagerness. Almost all the investors are purchasing the same asset. For a long period, the purchase of the asset appears to be profitable.

The difficulty is in predicting when the bubble would burst. According to experts, it would be prudent to manage a diversified portfolio of investments.

Diversification indicates a well-adjusted combination of shares, bonds, commodities. It would be advisable to monitor the asset distribution regularly. If there is an asset bubble in one particular asset of the portfolio, it would be the time sell that particular asset.

Central banks must play a positive role in limiting the impact of an asset bubble. They must not take any unnecessary risks and initiate measures to improve investor confidence. They should increase interest rates when asset bubbles expand. Another option would be to increase government expenditure. According to experts, not all asset bubbles cause damage, the differentiation being debt.

Real estate bubbles ignited by credit booms are the most unsafe. Capital markets impact the economy severally through the “wealth effect”. Any decrease in the value of an asset would result in less investment which, when combined with debt could lead to a downward trend.

Asset bubbles must be treated with caution. It could influence the economy adversely and result in recession. It would take a combined effort by various stakeholders to negate the ill effects of an asset bubble.

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