Discrepancy between real and perceived value triggers crashes from "summary" of Why Stock Markets Crash by Didier Sornette
The discrepancy between real and perceived value can trigger crashes in financial markets. This occurs when investors' perceptions of the value of an asset diverge significantly from its actual intrinsic value. This misalignment can create a bubble, where the price of the asset is inflated beyond its true worth. During a bubble, optimism and greed drive prices higher as investors believe that the asset will continue to appreciate in value. This positive feedback loop can lead to an unsustainable rise in prices, detached from the fundamental factors that should determine the asset's value. As the gap between real and perceived value widens, the bubble becomes increasingly fragile. Any event or piece of information that challenges the optimistic narrative can trigger a sudden change in sentiment. This shift in perception can lead to panic selling as investors rush to exit their positions, causing prices to plummet. Crashes occur when the bubble inevitably bursts, and the price of the asset reverts to its true value. This correction can be swift and severe, wiping out significant wealth in a short period of time. The magnitude of the crash is often proportional to the degree of the initial mispricing, with larger bubbles leading to more significant downturns.- Investors can avoid being caught up in speculative bubbles that are prone to crashing. Ultimately, the discrepancy between real and perceived value is a key driver of market volatility and can have profound implications for the stability of financial markets.
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