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Irrational Exuberance

Irrational Exuberance: (Second Edition)

Robert J. Shiller
Copyright Date: 2005
Pages: 344
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  • Book Info
    Irrational Exuberance
    Book Description:

    This first edition of this book was a broad study, drawing on a wide range of published research and historical evidence, of the enormous stock market boom that started around 1982 and picked up incredible speed after 1995. Although it took as its specific starting point this ongoing boom, it placed it in the context of stock market booms generally, and it also made concrete suggestions regarding policy changes that should be initiated in response to this and other such booms. The book argued that the boom represents a speculative bubble, not grounded in sensible economic fundamentals. Part one of the book considered structural factors behind the boom. A list of twelve precipitating factors that appear to be its ultimate causes was given. Amplification mechanisms, naturally-occurring Ponzi processes, that enlarge the effects of these precipitating factors, were described. Part Two discussed cultural factors, the effects of the news media, and of "new era" economic thinking. Part Three discussed psychological factors, psychological anchors for the market and herd behavior. Part Four discussed attempts to rationalize exuberance: efficient markets theory and theories that investors are learning. Part Five presented policy options and actions that should be taken.

    The second edition, 2005, added an analysis of the real estate bubble as similar to the stock market bubble that preceded it, and warned that "Significant further rises in these markets could lead, eventually, to even more significant declines. The bad outcome could be that eventual declines would result in a substantial increase in the rate of personal bankruptcies, which could lead to a secondary string of bankruptcies of financial institutions as well. Another long-run consequence could be a decline in consumer and business confidence, and another, possibly worldwide, recession." Thus, the second edition of this book was among the first to warn of the global financial crisis that began with the subprime mortgage debacle in 2007

    eISBN: 978-1-4008-2436-6
    Subjects: Economics, Finance, Business

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-viii)
  3. List of Figures and Tables
    (pp. ix-x)
  4. Preface to the Second Edition
    (pp. xi-xvi)
  5. Preface to the First Edition, 2000
    (pp. xvii-xxii)
  6. Acknowledgments
    (pp. xxiii-xxviii)
  7. One The Stock Market in Historical Perspective
    (pp. 1-10)

    When Alan Greenspan, as chairman of the Federal Reserve Board, first used the term irrational exuberance to describe the behavior of stock market investors, the world fixated on those words.¹ He spoke at a black-tie dinner in Washington, D.C., on December 5, 1996, and the televised speech was followed the world over. As soon as he uttered these words, stock markets dropped precipitously. In Japan, the Nikkei index dropped 3.2%; in Hong Kong, the Hang Seng dropped 2.9%; and in Germany, the DAX dropped 4%. In London, the FT-SE 100 was down 4% at one point during the day, and...

  8. Two The Real Estate Market in Historical Perspective
    (pp. 11-28)

    The same forces of human psychology that have driven the stock market over the years have the potential to affect other markets. The market for real estate, particularly individual homes, would seem likely to display speculative booms from time to time, since the psychological salience of the price of the places we see every day and the homes we live in must be very high, and because home prices are such a popular topic of conversation. Yet the market for real estate is different from the stock market in important ways.

    We have no shortage of recent examples of real...

  9. Part One Structural Factors

    • Three Precipitating Factors: The Capitalist Explosion, the Internet, and Other Events
      (pp. 31-55)

      What ultimately caused the values of the stock markets in so many countries to rise dramatically from 1982 to the remarkable peak around 2000? Why, even after a major correction, are the values of these markets still so high? What ultimately caused the boom in real estate markets in so many cities around the world to follow the stock market boom? To answer these questions, it is not enough to say that the markets in general are vulnerable to bouts of irrational exuberance. We must specify what precipitating factors from outside the markets themselves caused the markets to behave so...

    • Four Amplification Mechanisms: Naturally Occurring Ponzi Processes
      (pp. 56-82)

      In the previous chapter we examined a number of precipitating factors that have helped drive the stock market and the market for homes. In this chapter we consider how the effect of these factors is amplified by mechanisms involving investor confidence, investor expectations for future market performance, and related influences on investor demand. To provide context and concreteness, we shall first examine evidence about investor confidence and expectations.

      The amplification mechanisms work through a sort of feedback loop; later in this chapter they will also be described as a type of naturally occurring Ponzi process. Investors, their confidence and expectations...

  10. Part Two Cultural Factors

    • Five The News Media
      (pp. 85-105)

      The history of speculative bubbles begins roughly with the advent of newspapers.¹ One can assume that, although the record of these early newspapers is mostly lost, they, or their pamphlet analogues, reported on the first bubble of any consequence, the Dutch tulip mania of the 1630s.²

      Although the news media—newspapers, magazines, and broadcast media, along with their new outlets on the Internet—present themselves as detached observers of market events, they are themselves an integral part of these events. Significant market events generally occur only if there is similar thinking among large groups of people, and the news media...

    • Six New Era Economic Thinking
      (pp. 106-131)

      Speculative market expansions have often been associated with popular perceptions that the future is brighter or less uncertain than it was in the past. The term new era has periodically been used to describe these times.

      Of course, there is some obvious validity to the new era notion. The general trend over the past century was a rise in the standard of living and a decline in the impact of economic risks on individuals. By many measures the world has indeed been gradually growing into a new and better era. But the most salient characteristic of popular new era thinking...

    • Seven New Eras and Bubbles around the World
      (pp. 132-144)

      Large stock market moves like the U.S. examples I discussed in the previous chapter have also occurred in many other countries over the years, affording us numerous other observations. These suggest that speculative bubbles—periods of exaggerated but temporary investor enthusiasm, often associated with “new era” theories—are in fact commonplace.

      In this chapter, I examine the largest recent stock market moves around the world. For some of these, I rely on accounts by the news media. Of course, media accounts are not always reliable, and I cannot claim to have done exhaustive research on any of these examples. However,...

  11. Part Three Psychological Factors

    • Eight Psychological Anchors for the Market
      (pp. 147-156)

      We have seen that the market is not well anchored by fundamentals. People do not even know to any degree of accuracy what the “right” level of the market is: not many of them spend much time thinking about what its level should be or whether it is over- or underpriced today. So what is it that ties down the market’s level on any given day? What anchors the market? What is it that determines whether the Dow Jones Industrial Average is at 4,000 or 14,000? What ultimately limits the feedback from price changes to further price changes that amplifies...

    • Nine Herd Behavior and Epidemics
      (pp. 157-174)

      A fundamental observation about human society is that people who communicate regularly with one another think similarly. There is at any place and in any time a Zeitgeist, a spirit of the times. It is important to understand the origins of this similar thinking, so that we can judge the plausibility of theories of speculative fluctuations that ascribe price changes to faulty thinking. If the millions of people who invest were all truly independent of each other, any faulty thinking would tend to average out, and such thinking would have no effect on prices. But if less-than-mechanistic or irrational thinking...

  12. Part Four Attempts to Rationalize Exuberance

    • Ten Efficient Markets, Random Walks, and Bubbles
      (pp. 177-194)

      The theory that financial markets are efficient forms the leading intellectual basis for arguments against the idea that markets are vulnerable to excessive exuberance or bubbles. Extensive academic research has been widely seen as supporting this theory.

      The efficient markets theory asserts that all financial prices accurately reflect all public information at all times. In other words, financial assets are always priced correctly, given what is publicly known, at all times. Price may appear to be too high or too low at times, but, according to the efficient markets theory, this appearance must be an illusion.

      Stock prices, by this...

    • Eleven Investor Learning—and Unlearning
      (pp. 195-204)

      Besides the efficient markets argument, another rationalization for the exuberance in the stock market, as well as other speculative markets, is that the public at large has learned that the long-term value of the market is really greater than they had thought it was, and greater than conventional indicators would have suggested it should be. According to this rationalization, the price-earnings ratio in the stock market is higher today than the historical average because the public has now learned some simple facts, facts about historical returns and diversification or about the world situation. This argument differs from the efficient markets...

  13. Part Five A Call to Action

    • Twelve Speculative Volatility in a Free Society
      (pp. 207-230)

      The high valuations that the stock market attained at its peak in 2000, and the relatively high valuations that it still shows today, came about for no good reasons. The high valuations that the prices of homes attained in many markets by the opening years of the twenty-first century came about for no better reasons.

      The high stock market levels did not, as so many imagine, represent the consensus judgment of experts who have carefully weighed the long-term evidence. The markets have been high because of the combined effect of indifferent thinking by millions of people, very few of whom...

  14. Notes
    (pp. 231-270)
  15. References
    (pp. 271-286)
  16. Index
    (pp. 287-304)