Irrational exuberance refers to investor enthusiasm that drives asset prices higher than those assets fundamentals justify. The term was popularized by former Fed chairman Alan Greenspan in a 1996 speech, “The Challenge of Central Banking in a Democratic Society.”
Also, irrational exuberance is unfounded market optimism that lacks a real foundation of fundamental valuation, but instead rests on psychological factors.Irrational exuberance has become synonymous with the creation of inflated asset prices associated with bubbles, which ultimately pop and can lead to market panic.
But, when the ultimately bubble bursts, investors quickly turn to panic selling, sometimes selling their assets for less than they’re worth based on fundamentals. The panic that follows a bubble can spread to other asset classes, and can even cause a recession.
Example
Dot com bubble in 1990s
The dotcom bubble was a rapid rise in U.S. technology stock equity valuations fueled by investments in Internet-based companies during the bull market in the late 1990s. The value of equity markets grew exponentially during this period, with the technology-dominated Nasdaq index rising from under 1,000 to more than 5,000 between the years 1995 and 2000. Things started to change in 2000, and the bubble burst between 2001 and 2002 with equities entering a bear market.
The crash that followed saw the Nasdaq index, which rose five-fold between 1995 and 2000, tumble from a peak of 5,048.62 on March 10, 2000, to 1,139.90 on Oct. 4, 2002, a 76.81% fall. Even the share prices of blue-chip technology stocks like Cisco, Intel, and Oracle lost more than 80% of their value.
It took 15 years for the Nasdaq to regain its peak (To be precise, on 24 April, 2015).