Behavioral Finance: Take a peek at the Tulip Bubbles

May 7, 2015
Author: Scott Hanson

Tulip_image

Way back in the 1600s, an unprecedented demand for tulips caused a bidding war that brought Holland to its knees.From having little perceived value to becoming a national obsession, within 3 years tulips became one of the most valuable assets in the country, with one infamous transaction involving a twelve-acre estate that included two homes, a barn and a herd of sheep, all being traded for a single reddish-brown bulb.

So if tulips were at one time more valuable than gold, diamonds, or even land, how is it possible that today your neighbor probably has them growing in their yard?

The answer is both complex and simple, but it can be attributed to behavioral finance, which is a field of both economics and psychology. Just as it occurred during the American housing market of the last decade, or the dotcom bubble of the decade previous to that, or even the current U.S. stock market, the price inflation of tulip bulbs in the 1600s was not an accurate representation of their value.

But how did it end? The same way massive price inflation that is based on hysteria usually ends: badly. At the high-water mark of the frenzy, when everyone was “all in” and owning tulips had become a national obsession, the three preeminent tulip bulb brokers of the era, perhaps out of fear of contracting the bubonic plague (which was resurgent in Holland at the time), failed to show up for a major tulip auction. This set in motion a series of events that has been replayed time and time again throughout history: Be it land, housing, technology or tulips, an item’s “worth” is nothing more than perception. When markets roar and prices go up and up and up, the best course of action is often to sit back bemused and watch the chaos.

In closing, in the most general of terms, and when it comes to investing, keep your wits about you and be conservative when others are being greedy.

Related Topics:

Share This Post: