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Irrational Exuberance


Now that we are at the end of this book, let us discuss a few key learnings that this book had offered: 


1) It has been empirically observed that consumers, investors, bankers and the public kept expecting the stock market prices to increase further during the 1920s. The extremely high levels of the market reflected unjustified optimism and faith in the market. Increased volumes of trading despite extremely high levels of the market became common.


2) There was rapid asset price inflation and prices increased faster than incomes. The arrival of the Internet, the growth of mutual funds and the effects of the Baby Boom were regarded as the most important precipitating factors. Enhanced business reporting by the news and print media led to increased demand for stocks.


3) Mechanisms such as heightened investor confidence and high investor expectations for future market performances deeply magnified the effect of the precipitating factors. The formation of speculative bubbles causes the prices to increase further and a feedback loop occurs.


4) News media acts as an essential vehicle for the spread of ideas. The exaggeration of financial news by the media rouses the public which leads to the creation of more bubbles. They focus their attention on news that have word-of-mouth potential.


5) The term “new era” is used to describe a time when people think that the future is less uncertain than the past. This in turn causes huge stock market expansions. Observers reported real speculative fervour.


6) There emerged a tendency to ignore the possibility that the stock prices will fall in the future and that the economy might sink into a recessionary period. The rapid price increases were followed by incredibly dramatic reversals. There was a subsequent fall in the savings ratio and increase in borrowing activities.


7) People are often seen to be overconfident about one’s own thoughts & beliefs. This overconfidence proves to be a major factor in promoting the high volume of trade that we observe in the speculative markets


8) Herd behaviour gives rise to group behaviour that is irrational in nature. A growth in speculative or Ponzi lending has also been detected. People borrow money with the hope that the rising prices will earn them a huge profit even though they are not competent enough to repay their debts.


9) Markets are vulnerable to excessive exuberance or bubbles. Excess volatility due to speculative bubbles is one of the factors that drives speculative markets


10) Due to widespread “media coverage”, people now believe that the stock market is a less risky investment than what it once ought to be.


11) A rise in the interest rates & currency exchange rates is associated with the formation of bubbles. We observe the creation of inflated asset prices that are associated with the formulation of speculative bubbles.


As the wise men say, all bubbles eventually pop!

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Units 13/13