Irrational Exuberance Robert Shiller

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Irrational ExuberanceRobert Shiller

• Economics 71a
• Lecture notes 12.4

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Outline

• U.S Equity Markets in the 90s (1-2)
• News and the media (4)
• New era thinking (5)
• Psychology (7-8)
• Anchoring
• Herding
• Learning and unlearning (10)
• The market efficiency debate (9)

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Real SP 500 Price
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Real SP 500 P/E RatioPrevious 10 Year Earnings
(Shiller)
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Real SP 500 P/E RatioLatest 12 Month Earnings
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SP Annual Dividend Yield (d/p)
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Precipitating Factors

• Arrival of the internet during strong profit
  growth
• Reduction in foreign economic rivals
• Business culture
• Capital gains tax cuts
• Baby boom
• Media financial reporting
• Analyst optimism
• Defined contribution pension plans

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More Factors

• Growth of mutual funds
• Index funds
• Inflation declines
• Discount brokers
• Gambling opportunities

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Outline

• U.S Equity Markets in the 90s (1-2)
• News and the media (4)
• New era thinking (5)
• Psychology (7-8)
• Anchoring
• Herding
• Learning and unlearning (10)
• The market efficiency debate (9)

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News Media

• Record overload
• Stock market moves and big news
• Tag along news
• Crashes of 29 and 87
• New media outlets and rumors
• Internet sites

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Outline

• U.S Equity Markets in the 90s (1-2)
• News and the media (4)
• New era thinking (5)
• Psychology (7-8)
• Anchoring
• Herding
• Learning and unlearning (10)
• The market efficiency debate (9)

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New Eras

• New economy
• 1901
• Trains, electricity, new century
• 1920s
• Electricity, mass production, prohibition
• Irving Fisher
• 50s and 60s
• Baby boom, computers, credit cards, macroeconomic
  policy

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New Eras

• 90s
• Globalization
• Technology
• Low inflation (macro policy again)
• Profits
• Productivity

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Outline

• U.S Equity Markets in the 90s (1-2)
• News and the media (4)
• New era thinking (5)
• Psychology (7-8)
• Anchoring
• Herding
• Learning and unlearning (10)
• The market efficiency debate (9)

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Psychology Anchoring

• Decisions influenced by outside information
• Experiments with random wheel and questions
• Spin wheel (1-100)
• Ask factual question
• Above or below spin, then final answer
• Final answer impacted by wheel
• Stock prices
• Recent price as anchor
• Psychological barriers (round numbers)
• Recent minimums and maximums
• Trading range

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Moral Anchors

• Story telling and explanations
• Good stories and stocks
• Familiarity
• Invest in own company for retirement

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Overconfidence

• My judgment is better
• Good luck will persist
• Hot hands
• Search for familiar patters from past
• representativeness heuristic
• Trading volume
• Study on phone -gt online changes (page 59, Odean)
• Customers changes from phone to online
• Before change 2 above market
• After change 3 below market

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Herd Behavior

• Individuals influenced by groups
• Candid camera elevator
• Information cascades
• Restaurants
• Software
• Fashion
• Technologies
• Word of mouth
• News media
• News letters
• Internet

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More Herd Psychology

• Epedimic models
• Brain maintains conflicting models
• Focusing attention
• Too many stocks
• Too much data

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Outline

• U.S Equity Markets in the 90s (1-2)
• News and the media (4)
• New era thinking (5)
• Psychology (7-8)
• Anchoring
• Herding
• Learning and unlearning (10)
• The market efficiency debate (9)

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Learning in the Long Term

• Explanation for run up in the market
• Investors decide market is less risky
• Stocks are the place to invest
• Book Stocks For the Long Run, Siegel
• How does this explain things for us?
• Risk premia falling over time (k falls)
• What is risk, and how do people perceive it?

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Weakness in this Explanation

• It has been around before
• 1924 Edgar Lawrence
• Siegel data
• No 30 year period in which bonds have out
  performed stocks
• Except 1830-61
• What about 10 year periods?
• In 29-38 and 66-75 stocks under performed bonds
• Also, performance after all peaks is low (0-2
  real)

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More learning problems

• Learning to diversify
• Are investors getting better at this?
• Difficult problem

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Outline

• U.S Equity Markets in the 90s (1-2)
• News and the media (4)
• New era thinking (5)
• Psychology (7-8)
• Anchoring
• Herding
• Learning and unlearning (10)
• The market efficiency debate (9)

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Efficient Markets (Defined Again)

• Risk/Return
• Fair world
• Information
• Prices reflect all information
• Markets efficiently aggregate judgements

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Are There Clear Holes?

• Shiller Yes
• eToys valued at 8 billion
• Toys R Us at 6 billion
• Toys R Us has 400 times the sales of eToys
• eToys earnings negative 28.6 million
• Toys R Us earnings are 376 million
• Can you use this?

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Connecting Markets to Real Values

• Earnings
• Some periods (20s) strong
• Some periods (90s) much weaker
• Prices increase more than earnings
• Dividends
• Market crashes not justified by falls in
  dividends
• Summary
• Dividends and earnings dont move that much with
  prices
• Price variability much larger than earnings or
  dividend variability (Shiller figure 9.1)

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Counter to Shiller from Efficient Markets Side

• Markets not perfect, but
• Markets are still pretty hard to forecast
• Who are the smart people making money off all
  the inefficiency?
• Mutual fund evidence (Malkiel)

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My Thoughts on Market Efficiency

• Perfect efficient market world is wrong
• Pockets of inefficiency
• Can you capitalize on them?
• Do they affect the economy?

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Three Perspectives

• Individual investor
• Should you try to beat the market?
• Professional investor
• Are there places where the full time professional
  can add value?
• Policy makers
• Do markets excesses disrupt other parts of the
  economy?
• AOL/Time Warner

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Outline

• U.S Equity Markets in the 90s (1-2)
• News and the media (4)
• New era thinking (5)
• Psychology (7-8)
• Anchoring
• Herding
• Learning and unlearning (10)
• The market efficiency debate (9)