Anatomy of a Bubble
Market bubbles have occurred throughout financial history — from the Dutch Tulip Mania of 1637 to the Dot-com bubble of 2000 and the 2008 housing crisis. In each case, asset prices dramatically exceeded fundamental value before crashing. This simulator models the core mechanism: positive feedback loops between price changes and investor sentiment.
Minsky's Financial Instability Hypothesis
Economist Hyman Minsky (1986) argued that financial crises are not exogenous shocks but endogenous features of capitalist economies. During periods of stability, investors gradually take on more risk. Minsky identified three stages: hedge finance (income covers both principal and interest), speculative finance (income covers only interest), and Ponzi finance (income covers neither — relying entirely on asset appreciation). The transition to Ponzi finance is what inflates bubbles.
Herd Behavior and Feedback Loops
The herd behavior parameter models how much investors follow the crowd rather than fundamentals. When prices rise, optimistic sentiment attracts more buyers, pushing prices higher — a classic positive feedback loop. The speculation parameter amplifies how much this sentiment affects actual price movements. Together, they can drive prices far above the fundamental value trajectory (the dashed cyan line).
The Crash
Bubbles burst when speculative pressure exceeds a critical threshold. In real markets, this can be triggered by a change in monetary policy, a negative earnings surprise, or simply the exhaustion of new buyers. The crash is typically faster than the build-up — as Kindleberger observed, prices take the stairs up and the elevator down. The fear/greed indicator at the bottom of the chart shows how sentiment swings from euphoria to panic.
Reading the Simulation
The shaded area between the red price line and the cyan fundamental line represents overvaluation. Watch how increasing speculation and herd behavior inflates this area before an eventual correction. With low speculation, prices track fundamentals closely. With high values, dramatic boom-bust cycles emerge — the pattern Minsky predicted would occur endogenously in any unregulated financial system.