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Irrational Exuberance

New Eras And Bubbles Around The World

Large stock market moves like in the US have also occurred in numerous other countries which suggests that speculative bubbles that are associated with "new era" theories are in fact common. It was observed that record price movements in these countries reversed afterwards. 



The below table shows the twenty-five largest recent five-year real stock price index increases. It is based on monthly data starting at roughly the same dates. The rightmost column also shows what happened during the five years after each of these dramatic price changes. 


Largest Recent Five-Year Real Stock Price Index Increaes: 



Source Image: Irrational Exuberance



The biggest one-year real stock market increase of all (683.4%) happened in the Philippines from December 1985-86. The biggest five-year real price change of 1,253% also happened in the Philippines. One might suspect that the very low values for the Philippines stock market in December 1985 were the results of a negative bubble. 


The second biggest one-year increase and one-year decrease occurred in Taiwan. Booming exports had pushed economic growth rates, saving rates were extremely high and the country was investing heavily in its future. Volume of trade soared and the price-earnings ratio reached 45.


The third largest one-year price increase of 384.6% occurred in Venezuela from January 1990.


The fourth largest one-year price increase at 360.9% took place in Peru from August 1992.


The stock market increase in India from April 1991 began just as the assassination of Rajiv Gandhi ended the thirty eight-year Nehru family dynasty. If there actually was a new era, it seemed to many observers to be only in terms of market psychology.



The impact of the astonishing price increases were highly variable. They were quite frequently followed by dramatic reversals. Often the ends of bull markets appear to be caused by concrete events that are unrelated to any irrational exuberance in the stock market. For example - banking or exchange rate crisis. The ends of the "new eras" have a narrow technical basis, rather than a psychological or social basis. The 1994 Mexican crisis appears as the aftermath of one of the most spectacular five-year stock price increases. The Asian financial crisis of 1997-98 was also much more than a stock market crisis. It is assumed that the collapse of a speculative bubble in the various countries preceded the crisis and was part of the ambience that produced it. However, attention centered on changes in currency exchange rates, the sudden withdrawal of foreign investors, banking problems, inflation and labour difficulties.



If the price increases are, on average, reversed, then we have some evidence that the fundamental reasons were not sound. It was discovered by Werner De Bondt and Richard Thaler that winner stocks (if winner status is measured over long intervals of time such as five years) - tend to do poorly in subsequent intermissions of the same length. And that loser stocks (if loser status is measured over equally long intervals) tend to do well subsequently. With freer capital movements and more global investors seeking profit opportunities, markets may become more stable. The possibility of major speculative bubbles now and in the future cannot be ignored. Human tendencies bear on the plausibility of our view of speculative bubbles. 

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Units 7/13