Recent posts tagged ‘bubble’

I was traveling a few weeks ago to visit with institutional clients. For my travel reading, I downloaded Michael Lewis’s The Big Short. It’s a colorful look at some of the personalities during the great financial crisis of 2008–2009—in particular, the handful of market participants who saw the crisis coming.

I’ve been thinking a great deal about the dynamics of asset price bubbles, like the mortgage crisis or the internet stock craze. Recently I issued a Vanguard research paper sketching out a psychological model that might underlie the formation of bubbles. To put the paper’s argument in a simple way: The fundamental cause of bubbles seems to be a form of group self-delusion. Many (but not all) market participants develop a view of the future that is wholly unrealistic, and they disseminate this idea widely throughout the financial markets.

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Bubbles. We’ve just been through two of them in relatively short succession: the Internet bubble of the late 1990s, and the recent housing bubble.

Why do bubbles occur? The list of explanations includes shortsightedness, sheer stupidity, and greed. The history of bubbles is a story of excessive enthuasisms—for anything from tulip bulbs to subprime mortgages.

But is there something more fundamental at work? Something more innate and psychological? It seems to me there is. It arises from who we are as humans, and in how we think and behave, individually and as social animals. 

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