On Irrational Exuberance

I recently finished reading Irrational Exuberance by Robert J. Schiller.

This book serves as an awakening call from “the present…whiff of extravagant expectation, if not irrational exuberance, in the air. People are optimistic about the stock market. There is a lack of sobriety about its downside and the consequences that would ensue as a result.” The author advances that “we need to know if the price level of the stock market today, tomorrow, or any other day is a sensible reflection of economic reality, just as we need to know as individuals what we have in our bank accounts.” That being said, the purpose of the book is to advance “a better understanding of the forces that shape the long-run outlook for the market.”

This book covers a myriad of factors ranging from technology, to cultural to psychological that aid the formation and reinforcement of speculative bubbles. It ends with a section on implication of these findings on the various members of society whether individuals, institutions or government.

Below are key excerpts that I found particularly insightful:

1- “Many of the foregoing factors (that are candidates for causing a market boom) have  a self-fulfilling aspect to them, and they are thus difficult, if not impossible, to capture in predictive scientific explanations.”

2- “There are many ultimate causes for this exuberance…and the effect of these causes can be amplified by a feedback loop, a speculative bubble, as we have seen in his chapter. As prices continue to rise, the level of exuberance is enhanced by the price rise itself…The changes in thought patterns infect the entire culture and they operate not only directly from past price increases but also from auxiliary cultural changes that the past price increases helped generate.”

3- “The role of the news media in the stock market is not, as commonly believed, simply as a convenient tool for investors who are reacting directly to the economically significant news itself…The news media are fundamental propagators of speculative price movements through their efforts to make news interesting to their audience. ”

4- “Ends of new eras seem to be periods when the national focus of debate can no longer be upbeat. At such time, a public speaker may still think that it would be good business to extol a vision of a brilliant future for our nation’s economy, but it is simply not credible to do so. One could, at such times, present a case that the economy must recover, as it always has, and that the stock market is underpriced and should go up, but public speakers who make such a case cannot achieve the command of public attention they do after a major stock run-up and economic boom. There are times when an audience is receptive to optimistic statements and times when it is not.”

5- “We have explored the justification people have given, at various points in history, for changing market valuations, and we have seen evidence of the transitory nature of these cultural factors. Ultimately, however, the conclusions we draw from such evidence depend on our view of human nature and the extent of human abilities to produce consistent and independent judgements.”

6- “Two kinds of psychological anchors will be considered here: quantitative anchors, which themselves give indications for the appropriate levels of the market that some people use as indications of whether the market is over-or underpriced and whether it is a good time to buy, and moral anchors, which operate by determining the strengths of the reason that compels people to buy stocks, a reason that they must weigh against their other uses for the wealth which they already have (or could have) invested in the market.”

7- “The effects of new stories on the stock market sometimes have more to do with discovery of how we feel about the news than with any logical reaction to the news. We can make decisions then that would have been impossible before the news was known. It is partly for this reason that the breaking off of a psychological anchor can be so unpredictable: people discover things about themselves, about their own emotions and inclinations, only after price change occur. Psychological anchors for the market hook themselves on the strangest things along the muddy bottom of our consciousness.”

8- “Rationale response to public information is not the only reason that people think similarly, nor is the use of that public information always appropriate or well reasoned.”

9- “Policies that interfere with markets by shutting them down or limiting them, although under some very specific circumstances apparently useful, probably should not be high on our list of solutions to the problems caused by speculative bubbles. Speculative markets perform critical resource-allocation functions, and any interference with markets to tame bubbles interferes with these functions…Most of the thrust of our national policies to deal with speculative bubbles should take the form of facilitating more free trade, as well as greater opportunities for people to take positions in more freer markets. 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. The most important thing to keep in mind as we are experiencing a speculative bubble in the stock market today is that we should not let it distract us from such important tasks.”


Omar Halabieh

Irrational Exuberance


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