Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

Yes, There Is Such a Thing as a Rational Bubble -- We're in One Now

By

Double, double, toil and trouble, fire burn and caldron bubble. Why financial bubbles are not as crazy as they seem.

PrintPRINT
MINYANVILLE ORIGINAL When I got interested in finance in the late 1970s, the economy was in the midst of a real asset bubble. Financial assets-stocks and bonds-were hammered during that decade while real assets-real estate and commodities-soared. From 1976 to early 1980, the price of gold rose from $100 to $850 per ounce. Two years later, gold was under $300.

Jonathan Swift in 1721 was the first writer to use "bubble" to mean a public delusion that inflates the price of something without economic justification. But calling something a "delusion" or "the madness of crowds" is not helpful for prediction or explanation. While bubble investors as a group seem to be irrational, individually they can hope to sell at an even more inflated price than they buy, and in fact many people do make money investing in bubbles. The trick is to take out more money than you put in before the bubble pops.
This notion is the germ of the idea that bubbles might be explained without positing irrational actions. If so, not only would that deepen our understanding of bubbles, but it might point to ways to predict them, or perhaps to prevent them, or best of all, to modify them in ways that preserved their benefits while avoiding their costs.

There was a lot of work on rational bubbles from 1978 to 1987, but the stock market crash on October 19, 1987 pretty much ended it. The crash refocused most academic interest to behavioral explanations. There are several well-documented psychological mechanisms that can support irrational bubbles: Overconfidence, recency bias, confirmation bias, information cascades, reputational herding, and envy, among others.

Of course, all these mechanisms are real, and illuminate some aspects of bubbles. But despite years of efforts, behavioral work failed to generate non-obvious insights about historical bubbles. Individuals have biases, but that doesn't explain why other individuals don't figure this out and offset those biases, or why institutions do not develop to control the effect of individual biases.

The same behavioral theories that explain bubbles are also used to explain fashions, but fashion seems to revolve steadily rather than generating booms and busts. Behavioral theorists had no trouble explaining why interest in a financial idea might expand rapidly and then decline even more rapidly, just as clothing or music fads rise and fall. But going from this to a plausible and useful explanation of the economic effects of bubbles proved more difficult. In particular, behavioral models produced nothing but Monday morning quarterbacking regarding the Internet bubble that popped in 2000 and the housing bubble that popped in 2007.
< Previous
No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
PrintPRINT

Busy? Subscribe to our free newsletter!

Submit
 

WHAT'S POPULAR IN THE VILLE