Financial chart with growing and bursting bubbles in a surreal cityscape.

Decoding Bubble Necessity: When Asset Prices Must Defy Reality

Beau Callahan in Business & Economy December 2025 • 4 min read.

"Explore the groundbreaking "Bubble Necessity Theorem" and discover why bubbles might be inevitable in certain economies, challenging conventional financial wisdom."

Asset price bubbles – those periods when asset prices soar far beyond any rational fundamental value based on dividends – have long been viewed with suspicion and concern. Traditionally, financial models have treated bubbles as anomalies, possibilities to be cautiously accounted for or even dismissed as irrational exuberance. But what if bubbles weren't just a glitch in the system? What if, under certain economic conditions, they were actually inevitable?

Enter the "Bubble Necessity Theorem," a provocative idea challenging the very foundation of how we understand asset pricing. This theorem suggests that in a wide range of plausible economic scenarios, bubbles are not merely potential occurrences but a necessary feature of market equilibrium. This means that instead of trying to prevent or eliminate bubbles entirely, we might need to understand and manage them as an inherent part of the economic landscape.

This article will unpack this groundbreaking concept, diving into the core arguments of the Bubble Necessity Theorem and exploring its implications for investors, policymakers, and anyone trying to make sense of today's complex financial markets. We'll break down the complex economics into understandable insights, revealing when and why bubbles might be unavoidable – and what we can do about it.

The Bubble Necessity Theorem: A New Lens on Market Behavior

Financial chart with growing and bursting bubbles in a surreal cityscape.

The traditional view of asset bubbles is that they represent a deviation from efficient market behavior. In a perfect world, asset prices should accurately reflect the present value of future dividends – the fundamental value of the asset. Bubbles, in this view, are caused by irrational speculation, market imperfections, or psychological factors that drive prices away from this fundamental value.

The Bubble Necessity Theorem flips this perspective on its head. It argues that in certain economic models, specifically those with:

Faster long-run economic growth (G) than dividend growth (G_d).
A counterfactual long-run autarky interest rate (R) below dividend growth.

…bubbles are not just possible but unavoidable. In other words, under these conditions, every market equilibrium will exhibit asset price bubbles with sizes that are significant relative to the overall economy. The theorem suggests that these conditions naturally arise in economies with strong savings motives and multiple factors or sectors experiencing uneven productivity growth.

Challenging Conventional Wisdom

The Bubble Necessity Theorem presents a powerful challenge to conventional financial thinking. It suggests that instead of viewing bubbles as purely negative phenomena to be eradicated, we need to understand the economic conditions that make them inevitable and develop strategies for managing their impact. This could involve rethinking regulatory approaches, refining investment strategies, and developing new tools for assessing market risk. By embracing this new perspective, we can move towards a more nuanced and realistic understanding of how financial markets operate.

About this Article -

This article was crafted using a human-AI hybrid and collaborative approach. AI assisted our team with initial drafting, research insights, identifying key questions, and image generation. Our human editors guided topic selection, defined the angle, structured the content, ensured factual accuracy and relevance, refined the tone, and conducted thorough editing to deliver helpful, high-quality information.See our About page for more information.

This article is based on research published under:

DOI-LINK: 10.1086/732528,

Title: Bubble Necessity Theorem

Subject: econ.th q-fin.mf

Authors: Tomohiro Hirano, Alexis Akira Toda

Published: 14-05-2023

Everything You Need To Know

What is the Bubble Necessity Theorem?

The Bubble Necessity Theorem is a concept that challenges the traditional view of asset bubbles. It posits that in certain economic conditions, bubbles are not merely possible but are actually a necessary feature of market equilibrium. This theorem suggests that instead of trying to eliminate bubbles entirely, we should understand and manage them as an inherent part of the economic landscape. The theorem identifies specific conditions, such as faster long-run economic growth (G) than dividend growth (G<sub>d</sub>) and a counterfactual long-run autarky interest rate (R) below dividend growth, where bubbles become unavoidable.

How does the Bubble Necessity Theorem change our understanding of asset pricing?

The Bubble Necessity Theorem fundamentally shifts our perspective on asset pricing. The traditional view sees bubbles as deviations from efficient market behavior, caused by irrational speculation. In contrast, the theorem argues that bubbles are an integral part of market dynamics under specific economic conditions. It suggests that bubbles arise naturally in economies with strong savings motives and uneven productivity growth across different sectors. This perspective requires investors, policymakers, and analysts to understand and manage bubbles, rather than solely trying to prevent them. By embracing this new view, a more nuanced and realistic understanding of financial market operation can be achieved.

What economic conditions make bubbles unavoidable according to the Bubble Necessity Theorem?

According to the Bubble Necessity Theorem, bubbles become unavoidable when specific economic conditions are met. These conditions include faster long-run economic growth (G) than dividend growth (G<sub>d</sub>) and a counterfactual long-run autarky interest rate (R) that is below dividend growth. These conditions often arise in economies that exhibit strong savings behavior and varying productivity growth across different sectors. The theorem indicates that under these circumstances, market equilibrium will inevitably exhibit asset price bubbles that are significant relative to the overall economy.

What are the implications of the Bubble Necessity Theorem for investors?

The Bubble Necessity Theorem has significant implications for investors. Instead of viewing bubbles solely as risks to be avoided, investors are encouraged to understand the economic conditions that make them inevitable. Investors can refine their strategies to manage the impact of bubbles. This could involve developing tools for assessing market risk, considering regulatory approaches, and adjusting investment strategies to account for the presence of bubbles. By adopting a more informed perspective, investors can potentially navigate financial markets more effectively in economies where bubbles are inherent.

How does the Bubble Necessity Theorem differ from the traditional view of asset bubbles?

The Bubble Necessity Theorem dramatically differs from the traditional view of asset bubbles. The traditional view perceives bubbles as deviations from the efficient market hypothesis, caused by irrational speculation, market imperfections, or psychological factors. This perspective treats bubbles as anomalies to be cautiously managed or eliminated. The Bubble Necessity Theorem, conversely, argues that bubbles are a necessary feature of market equilibrium in certain economic scenarios. It suggests that bubbles arise naturally and are not necessarily negative phenomena. The theorem encourages understanding the conditions that make bubbles inevitable and developing strategies for managing their impact.