Sunday, August 30, 2009

What causes bubbles?

In the second edition of our textbook, we discuss the feedback mechanism that causes asset bubbles:  when price goes up (or down) in one period, expectations form that price will continue up (or down) next period.  In today's NY Times, Bubbleologist Robert Shiller looks at the mechanics behind these feedback loops
A downward movement in stock prices, for example, generates chatter and media response, and reminds people of longstanding pessimistic stories and theories. These stories, newly prominent in their minds, incline them toward gloomy intuitive assessments. As a result, the downward spiral can continue: declining prices cause the stories to spread, causingstill more price declines and further reinforcement of the stories.

5 comments:

  1. And what causes a bunch of professors who have never done anything (those who can't do, teach) to sit around and try to play "i told you so" about the bubble afterwards? It was the guys who had the nuts to get out there in the first place (who, yes caused a bubble) who could probably best answer this question but they haven't toiled their lives away in some one window shit hole office at a business school their whole life so they aren't ready willing and able to slap an opinion up on the internet at any given time. lol

    ReplyDelete
  2. Ouch!

    Well, it's hard to let a comment like that just pass by. And, I can't really speak for my co-bloggers, but this comment is in no way applicable to me. I have two windows in my office!

    ReplyDelete
  3. It is easier to look at the past and say someone is correct or not! With my meager knowledge of statistics and probability I would say that someone is always right at some point in time and the person can beat on his chest for skills or just consider himself/herself lucky!

    ReplyDelete
  4. Shiller has made two unbelievable calls on both the tech bubble in 1999; and on the real estate bubble in 2005 (and as far as I know, put his own money where his mouth was).

    That being said, anomymous is correc that most of us arm chair philosophers do NOT have the guts to bet on what we teach: "If we are so smart, how come we are not rich."

    ReplyDelete
  5. Here is a far more simple, personal, and dare I say accurate way to think about what causes financial bubbles:

    http://actualanarchy.blogspot.com/2011/04/easier-way-to-think-about-bubbles.html

    ReplyDelete