Customer Reviews

Bubbleology: The New Science of Stock Market Winners and Losers

5 star:		(2)
4 star:		(1)
3 star:		(1)
2 star:		(0)
1 star:		(1)

 

 

Despite Mr. Hassett's track record with his previous book "Dow 36,000," I saw him appear on CNBC during the early morning show and thought that he did well enough that I should buy the book. He promised that you could use his book to figure out what stocks were overvalued and which ones weren't. A pretty important topic given the current market environment. However, after reading this short book I have no idea of how to actually rank stocks on the 1 to 6 scale that he uses. He doesn't actually provide concrete examples, only that he says that he put together this ranking and it worked really well. My other problem is that if this approach works so well how come he didn't use it when his "Dow 36,000" book came out when the stock market was at its peak. Some explanation would have been useful for why Hassett, who is marketing this book as a full proof approach to spotting bubbles, wasn't able to use this approach himself over just the last couple of years to warn people and predict which stocks were going to crash, a period when he was supposedly writing this book. Claiming that you use a not clearly stated formula to identify overvalued stocks after they have already crashed seems like a scam to me.

I saw a favorable review in the New Yorker so I took the plunge and bought the book, even though I never read finance books. This is one of the most interesting books I have ever read. While its easy to say there was a bubble after the fact, this book looks at the work of the real scientists who have been searching for hard scientific evidence of bubbles. The book has very well done dialogues that help make the material entertaining. I never expected that the search for bubbles would provide so much insight into how the world works.

Hassett has improved his scholarship immensely in the present book over his previous,co-authored book with James Glassman ,written in 1999, which predicted a Dow of 35,000 by late 2005.The fundamental problem underlying the formation of a boom-bust stock market(herd,crowd, and momentum investing,financed in large part by margin account loans,that leads to manias,bubbles,panics,crashes and subsequent economic downturns)is the inherent ambiguity(uncertainty) of the information or data upon which stock market participants are basing their expectations and probabilistic forecasts of future price changes.The inability to form reliable probabilistic forecasts of future market outcomes leads perfectly rational decision makers to start to follow other market participants who they think might be somewhat better informed.The formation of herd behavior is then started and you are well down the road to boom and bust capitalism.Hassett correctly credits D.Ellsberg,F.Knight,and J.M.Keynes for providing the fundamental concepts underlying his "new" "science" of stock market analysis.Essentially,any type of classical-neoclassical analysis based on the assumption of normality(a normal probability distribution a la the efficient markets type of reasoning) is shown to be badly misleading and very inaccurate.The ambiguity(uncertainty)versus risk distinction is of fundamental importance for any type of financial investing or modeling.There are two significant omissions in Hassett's book.The first omission is Ellsberg's 1962 dissertation,recently published in 2001.Hassett gives Gilboa and Schmeidler unwarranted credit for incorporating optimism-pessimism into Ellsberg's decision theoretic technical structure.Ellsberg had already integrated a generalization of the Hurwicz optimism-pessimism index into his general model of decision making under ambiguity in the very important chapter 7 of his dissertation.Gilboa and Schmeidler, unfortunately,conflate the existence of ambiguity with optimism and pessimism.Supposedly,optimists are ambiguity preferrers and pessimists are ambiguity averse.Decision making that is conservative in nature,i.e.,careful,prudent,circumspect,that "does not rush in where angels fear to tread",also appears to be mislabeled as "pessimism".Ellsberg makes it completely clear that his rho index is separate from his optimism-pessimism index.Likewise,conservatism in decision making is not the same as pessimism in decision making under conditions of ambiguity.Gilboa and Schmeidler deserve some credit for applying a more advanced mathematical technique[Choquet integration using capacities(convex-concave),a generalization of mathematical probability functions that allow non additivity (sub and super additive capacities) to be incorporated using ranked data].However,they have made no theoretical or empirical advance over Ellsberg's chapter 7 presentation .The purely mathematical advance made by Gilboa and Schmeidler appears to have been overemphasized in the economics journal literature.Gilboa and Schmeidler need to straighten out their analysis so as to separate ambiguity from optimism-pessimism and distinguish conservatism from pessimism. The second major oversite made by Hassett is that none of the 50 years of work done by Benoit Mandelbrot on analyzing stock and financial market pricing data is referenced.Mandelbrot's mild risk(normal distribution-random walk-efficient markets-independence-continuity)versus wild risk(Cauchy distribution-discontinuities-long and short run dependence-correlated variances)distinction is of great importance theoretically and empirically.Mandelbrot has established empirically the unstable, boom -bust nature of capitalism.The markets are far,far more risky than is assumed by the economics establishment.An overwhelming case can be made that the work of Ellsberg and Mandelbrot is so important that they should receive the Nobel prize in economics in 2006.

I am somewhat more dubious than Kevin Hassett is about the existence of "bubbles" (e.g., see PeterGarber's excellent review of the history of bubbles in "Fables that Aren't Worth the Price of a Tulip"), but given that Hassett provides the latest academic research in an understandable readable way on how to spot when bubbles might be occurring, this is a very useful book. I think for the vast majority of readers the book strikes the right balance between practical usefulness and technical detail. It is a hard task, but I have rarely seen someone take what can be such technically complicated issues and get the logic of what is going on in such a straightforward way. For investors, this is a very useful book to read.

The young co-author of Dow 36,000 writes a summary of theories regarding financial bubbles. (Thank goodness he doesn't pursue the earlier book's theory on the stock market's risk premium.) Unfortunately, this is not a practical bubble detector.
This is a quick, pithy read with lots of information and a bibliography to point the way for further study. He contrasts the efficient market theory with other ideas that suggest the market can be beaten. It's too bad this book is not longer and more substantial. Maybe Devil Take the Hindmost or Tulipomania would make a nice follow up to this simple intro.