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Humans Tend Toward Bubbles
December 26, 2008 |
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One sentence in particular stuck out in this Crooked Timber entry about predictions of the economic crisis: "The big problem for the Cassandras (and we were certainly both correct and disregarded) was that it was easy to see that the bubble could not continue and much harder to foresee how it would end - it's one thing to say that dark matter must exist and another to work out what it is really like."
As Virginia Postrel pointed out in the Atlantic recently, there is a human tendency towards bubbles. In the article she talks about a very interesting experiment: "take a bunch of volunteers, usually undergraduates but sometimes businesspeople or graduate students; divide them into experimental groups of roughly a dozen; give each person money and shares to trade with; and pay dividends of 24 cents at the end of each of 15 rounds, each lasting a few minutes." It's an "efficient market" where everyone knows the same as everyone else and they all know exactly how much the securities are worth. However, every experiment turns up the same thing: "the trading price runs up way above fundamental value. Then, as the 15th round nears, it crashes." Bubbles, it seems, are a fundamental part of who we are as people.
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