This recently published, revised and expanded edition of Robert Shiller’s “Irrational Exuberance”, available now for the first time in paperback, is an excellent reason to get acquainted with a classic on economics and financial markets.
Nobel-Prize winning economist Shiller warned of both the tech and housing bubbles and much of his work deals with the creation of new financial structures.
Written in the wake of the 2008-2009 financial crisis, “Irrational Exuberance” focuses on the behavior of investors and markets. In the preface to the third edition, Shiller acknowledges that after the financial crisis, we should be living in a different world. But variations in the stock and bond markets have soared in the US and other countries despite a “disappointing world recovery”, and most investors also ignore the troubling lack of credibility in the quality of research being done on the stock market.
“Some of this so-called research often seems no more rigorous than the reading of tea leaves,” Shiller writes.
Shiller tries to understand the change in thinking of people whose actions influence the markets. People continue to have unrealistic hopes in the markets and believe they will continue to rise. This book is mainly “about the psychology of speculation, about the feedback mechanism that intensifies this psychology, about herd behavior that can spread through millions – or even billions – of people and about the implications of such behavior.”
The first chapter offers an historical perspective of the stock market and an explanation for the book’s title, inspired by an Allan Greenspan speech at a black-tie dinner in December 1999. Greenspan’s speech was televised and as soon as he pronounced these two words – “irrational exuberance” – to describe the behavior of investors, stock markets all over the world immediately dropped. This highlights how the markets can behave.
Shiller describes “a situation in which news of price increases spurs investor enthusiasm which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the increases and bringing in a larger class of investors who, despite doubts about the real value of an investment, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement.”
What is interesting is that even when he was chairman of the Federal Reserve Board, there were times when Greenspan seemed unsure. He was always very careful when he was speaking in public. He was also known for asking questions rather than answering them.
In order to explain why the markets behave so dramatically, Shiller brings up a number of causes or precipitating factors.
Topping the list is the Internet which has made us profoundly conscious of the pace of technological change. The Internet is considered as important innovation as the personal computer or the television. Most of all, using the Internet gives us the feeling that we dominate the world.
Another factor is the prospect of losing one’s job. Fearing the loss of a job, people take greater risks with their investments in order to keep alive the hope of living comfortably in the future without working. Around the world, and especially in developed countries, people are noticing the growing trend of job-replacing technology. The digital economy and the increasing use of robots are playing an important part in our lives. People wonder where this technology is taking the world and how many jobs it will replace. Consequently people who fear losing their jobs tend to be prepared to pay more for long-term assets in order to save for the difficult years ahead.
The fear of unemployment in the near future and the rapid development of the digital economy is also a source of anger and conflict which is causing the rise of nationalistic and populist political parties.
Other factors for the recent booms in the stock market, the bond market and real estate include the growth of mutual funds, the decline of inflation, expansion of the volume of trade and an extremely loose monetary policy – to name only a few. We are reminded, however, that “there is no air-tight science of speculative market pricing. We have certainly made progress in understanding the markets but the complexity of real life continues to prevail.”
Later in the book, Shiller focuses on the psychological factors which affect the financial markets. One is the tendency to have overconfidence in one’s beliefs. “People think they know more than they do. They like to express opinions on matters they know little about and they often act on these opinions.”
According to Shiller, the speculative volatility of the markets is due to the combined effects of indifferent thinking by millions of people, very few of whom have felt the need to perform careful research on long-term investment value. The news media also plays an important part in influencing people’s decisions, especially if they lack the knowledge to make a proper decision.
Shiller cautions us not to be lulled into complacency by past investment successes. He also enjoins us to remember that the level of returns in the past is no guarantee of the same in the future. Ultimately he believes that a government can neither protect people from the consequences of their own errors nor from the waves of irrational exuberance or irrational pessimism.
“A good outcome can be achieved by designing better forms of social insurance and creating better financial institutions to allow the real risks to be managed more effectively,” Shiller concludes.
This summarizes the aim of his work – which focuses on the need to both democratize and humanize finance.
—
Email: [email protected]
Nobel-Prize winning economist Shiller warned of both the tech and housing bubbles and much of his work deals with the creation of new financial structures.
Written in the wake of the 2008-2009 financial crisis, “Irrational Exuberance” focuses on the behavior of investors and markets. In the preface to the third edition, Shiller acknowledges that after the financial crisis, we should be living in a different world. But variations in the stock and bond markets have soared in the US and other countries despite a “disappointing world recovery”, and most investors also ignore the troubling lack of credibility in the quality of research being done on the stock market.
“Some of this so-called research often seems no more rigorous than the reading of tea leaves,” Shiller writes.
Shiller tries to understand the change in thinking of people whose actions influence the markets. People continue to have unrealistic hopes in the markets and believe they will continue to rise. This book is mainly “about the psychology of speculation, about the feedback mechanism that intensifies this psychology, about herd behavior that can spread through millions – or even billions – of people and about the implications of such behavior.”
The first chapter offers an historical perspective of the stock market and an explanation for the book’s title, inspired by an Allan Greenspan speech at a black-tie dinner in December 1999. Greenspan’s speech was televised and as soon as he pronounced these two words – “irrational exuberance” – to describe the behavior of investors, stock markets all over the world immediately dropped. This highlights how the markets can behave.
Shiller describes “a situation in which news of price increases spurs investor enthusiasm which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the increases and bringing in a larger class of investors who, despite doubts about the real value of an investment, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement.”
What is interesting is that even when he was chairman of the Federal Reserve Board, there were times when Greenspan seemed unsure. He was always very careful when he was speaking in public. He was also known for asking questions rather than answering them.
In order to explain why the markets behave so dramatically, Shiller brings up a number of causes or precipitating factors.
Topping the list is the Internet which has made us profoundly conscious of the pace of technological change. The Internet is considered as important innovation as the personal computer or the television. Most of all, using the Internet gives us the feeling that we dominate the world.
Another factor is the prospect of losing one’s job. Fearing the loss of a job, people take greater risks with their investments in order to keep alive the hope of living comfortably in the future without working. Around the world, and especially in developed countries, people are noticing the growing trend of job-replacing technology. The digital economy and the increasing use of robots are playing an important part in our lives. People wonder where this technology is taking the world and how many jobs it will replace. Consequently people who fear losing their jobs tend to be prepared to pay more for long-term assets in order to save for the difficult years ahead.
The fear of unemployment in the near future and the rapid development of the digital economy is also a source of anger and conflict which is causing the rise of nationalistic and populist political parties.
Other factors for the recent booms in the stock market, the bond market and real estate include the growth of mutual funds, the decline of inflation, expansion of the volume of trade and an extremely loose monetary policy – to name only a few. We are reminded, however, that “there is no air-tight science of speculative market pricing. We have certainly made progress in understanding the markets but the complexity of real life continues to prevail.”
Later in the book, Shiller focuses on the psychological factors which affect the financial markets. One is the tendency to have overconfidence in one’s beliefs. “People think they know more than they do. They like to express opinions on matters they know little about and they often act on these opinions.”
According to Shiller, the speculative volatility of the markets is due to the combined effects of indifferent thinking by millions of people, very few of whom have felt the need to perform careful research on long-term investment value. The news media also plays an important part in influencing people’s decisions, especially if they lack the knowledge to make a proper decision.
Shiller cautions us not to be lulled into complacency by past investment successes. He also enjoins us to remember that the level of returns in the past is no guarantee of the same in the future. Ultimately he believes that a government can neither protect people from the consequences of their own errors nor from the waves of irrational exuberance or irrational pessimism.
“A good outcome can be achieved by designing better forms of social insurance and creating better financial institutions to allow the real risks to be managed more effectively,” Shiller concludes.
This summarizes the aim of his work – which focuses on the need to both democratize and humanize finance.
—
Email: [email protected]
