Irrational Exuberance.Schiller, Robert J.
Princeton, New Jersey
Princeton, New Jersey is located in Mercer County, New Jersey, United States. Princeton University has been sited in the town since 1756. : Princeton University Princeton University, at Princeton, N.J.; coeducational; chartered 1746, opened 1747, rechartered 1748, called the College of New Jersey until 1896. Schools and Research Facilities
Press, 2000. (312 pp)
If Irrational Exuberance Irrational Exuberance
An infamous phrase uttered by Alan Greenspan in 1996 to describe the overvalued market at the time.
Although every word spoken by Mr. could be summed up in one sentence, it could be this: "Absurd prices sometimes last a long time."
Amplifying on Federal Reserve Board Chairman Alan Greenspan's now famous remark that the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. stock market investors are in a state of "irrational exuberance," the book tries to document that we are a) in the midst Adv. 1. in the midst - the middle or central part or point; "in the midst of the forest"; "could he walk out in the midst of his piece?"
midmost of a market "bubble" where the valuation of the stock market has ballooned since 1982, and b) explain why markets have bubbles from time to time.
In explaining why markets have bubbles, he succeeds in poking holes in the efficient markets hypothesis, which dominates finance. However, what new theory would take its place is not clear (it may be that just a minor alteration in the efficient markets theory is needed). His theory is hard to ascertain, in part because it is deduced much later in the book. On page 167, he summarizes the phenomenon: exogenous Exogenous
Describes facts outside the control of the firm. Converse of endogenous. factors put in play a media-fueled bubble; stock price increases beget be·get
tr.v. be·got , be·got·ten or be·got, be·get·ting, be·gets
1. To father; sire.
2. To cause to exist or occur; produce: Violence begets more violence. demand for stocks which in turn beget further stock price increases. This describes the mechanics of a bubble, but underlying this relatively rare event are deep psychological forces that usually lie dormant Verb 1. lie dormant - be inactive, as if asleep; "His work lay dormant for many years" and cause investors to behave irrationally.
The book is structured into five sections, preceded by an opening chapter where he quickly presents the case of an overvalued Overvalued
A stock whose current price is not justified by the earnings outlook or price/earnings (P/E) ratio and thus, expected to drop in price. Overvaluation may result from an emotional buying spurt, which inflates the market price of the stock or from a deterioration in a stock market. The evidence hinges on the fact that prices of stocks are at a historic high in relation to aggregate corporate earnings--indeed, higher than in 1929. While his argument is compelling, it should be noted that bubbles cannot really be known until after the fact. As noted in an interview between the GFOA GFOA Government Finance Officers Association newsletter Public Investor and Federal Reserve Board Governor Edward Gramlich Edward M. Gramlich (July 18 1939 – September 5 2007) was a professor of economics at the University of Michigan and a former member of the Board of Governors of the Federal Reserve. , "bubbles can never be identified ex ante, only ex post, and we are not sure if there is a bubble out there or not."  Thus, it would be useful to strengthen the link in this chapter that high price-earning ratios equate with a market bubble (he does address it much later in the book in the context of whether there has been a broad-based shift in how investors view the risk of stocks). In addition, he implies negative returns on stock investments in the years ahead because of the high price-ear ning ratio. However, he overlooks the "soft-landing" argument--that stocks could still grow, but, say, at 8 percent per year instead of the faster growth seen historically.
In Part One, Shiller explains the structural factors that he believes have caused the dramatic 1982-2000 run-up in stock prices (such as the rise of mutual funds). In particular, he attributes the 1997-2000 period, where the market has increased even faster, to such factors as the Internet and on-line trading. Taken together, these factors seem to have triggered the start of a cycle whereby the stock appreciation leads the expectation of stock appreciation which in turn yields further stock appreciation.
Part Two digs deeper into the factors associated with the 1982-2000 market boom. Here, he finds fault with the media, because in the urge to report something newsworthy news·wor·thy
adj. news·wor·thi·er, news·wor·thi·est
Of sufficient interest or importance to the public to warrant reporting in the media.
news they focus on events such as the market exceeding 10,000, which seem to encourage market euphoria. Moreover, media coverage shifts people's limited attention to stories about the market rather than non-financial news. As in the 1920s, everyone seems to be talking about the market. Moreover, the prevailing public attitude of a technology revolution mirrors the attitudes seen during the market booms of the 1920s and 1950s, when the automobile and television redefined everyday life.
Part Three puts forward psychological factors that drive investment decisions. In this section, Shiller relies on the growing behavioral finance Behavioral Finance
A field of finance that proposes psychology-based theories to explain stock market anomalies. Within behavioral finance it is assumed that the information structure and the characteristics of market participants systematically influence individuals' investment literature that questions the efficient market theorists. He conveys to the lay reader how individuals really make investment decisions, relying not on fundamental security analysis but on stories on why a particular company is so good or on anchors, e.g., irrelevant but seemingly significant numbers like the Dow at 10,000.
Not only do individuals process information in an irrational way, they do so as a group. Because of word-of-mouth communication, perceptions about the market can be transmitted like an epidemic. The Year 2000 bug n. 1. (Computers) an error in the coding of certain computer programs in which the year portion of dates was represented by only two decimal digits, assuming that the first two digits are "19". In such a program the the year 1975 is represented as "75". is an example of a fear that spreads rapidly by word of mouth that proved, in his opinion, groundless.
Part Four is an attack on the efficient markets theory. He puts forward reasons for, and evidence of, mispricing that is at odds with the notion of the efficient market theory. For example, Internet stocks like eToys had stock capitalizations that exceeded their bricks-and-mortar competitors. Such mispricing persists; it is not just a phenomenon that can be explained as a temporary anomaly. Finally, he argues against the notion that a) investors have collectively learned that stocks are not really that risky when invested for a long-term goal like retirement (i.e., the notion that stocks almost always do well over 20- or 30-year periods) and b) this societal learning explains a permanent change in the equity risk premium (the additional return investors demand for investing in stocks instead of a safer investment like Treasury bonds). Again, he makes a well-reasoned case by arguing that people learned the lesson that stocks are superior long-term investments in the 1920s and then unlearned it. However, maybe investors' collective judgment may be rational after all--given that the political risk to owning stocks has declined. 
Part Five suggests a course of action. For investors, he supports:
* greater diversification--diversification means not just owning a mutual fund(s) made up of different flavors of domestic stocks;
* decreased "reliance on the stock market in...ongoing investment decisions"--for example, choosing other investments for future purchases;
* increased saving; and
* redesigned defined contribution (DC) plans.
On balance, this book provides an excellent, well written examination of market bubbles which serves as a healthy reminder that stock investing is riskier than commonly perceived. Moreover, it offers--if not a fully developed theory--a new understanding for how prices are set for individual stocks and the market as a whole. The theory is not easy to sum up, but it is a convincing counter to the efficient market theory which may itself have contributed to the recent lift off in U.S. stock prices.
This book will be relevant to pension administrators as well as budget officials who earmark earmark
taking a piece out of the edge or center of the ear with a punch as an identification mark. The shape of the mark may be registerable under local legislation. government appropriations for pensions each year. Budget officials may be tempted to stop contributing to overfunded pension contributions each year since the market is essentially doing the work for them of growing the asset base needed to pay for liabilities of future retirees. They also may be tempted to let pension liabilities Pension liabilities
Future liabilities resulting from pension commitments made by a corporation. Accounting for pension liabilities varies widely by country. grow if assets grow. Finally, elected officials who set policy should read this book when considering changing the design of pension benefits.
Irrational Exuberance can be obtained for $27.95 from Princeton University Press, 41 William Street William Street may refer to:
(1.) He added that "Even if we were [in a bubble], it is hard to know how to prick it without damaging the overall economy. The modern thinking on stock market bubbles A stock market bubble is a type of economic bubble taking place in stock markets when price of stocks rise and become overvalued by any measure of stock valuation.
The existence of stock market bubbles is at odds with the assumptions of efficient market theory which assumes , or at least the thinking of many economists, is that the Fed should just do its job, stabilizing inflation and output growth rates Growth Rates
The compounded annualized rate of growth of a company's revenues, earnings, dividends, or other figures.
Remember, historically high growth rates don't always mean a high rate of growth looking into the future. . The stock market is one input in these types of decisions, but should not be a separate target of policy."
(2.) In addition to former communist countries, other developed and developing economies have adopted free market policies in the past 20 years.