Irrational Exuberance [Paperback]

Robert J. Shiller (Author)

Book Description

Release date: May 9, 2006

As Robert Shiller’s new 2009 preface to his prescient classic on behavioral economics and market volatility asserts, the irrational exuberance of the stock and housing markets “has been ended by an economic crisis of a magnitude not seen since the Great Depression of the 1930s.” As we all, ordinary Americans and professional investors alike, crawl from the wreckage of our heedless bubble economy, the shrewd insights and sober warnings, and hard facts that Shiller marshals in this book are more invaluable than ever.

The original and bestselling 2000 edition of Irrational Exuberance evoked Alan Greenspan’s infamous 1996 use of that phrase to explain the alternately soaring and declining stock market. It predicted the collapse of the tech stock bubble through an analysis of the structural, cultural, and psychological factors behind levels of price growth not reflected in any other sector of the economy. In the second edition (2005), Shiller folded real estate into his analysis of market volatility, marshalling evidence that housing prices were dangerously inflated as well, a bubble that could soon burst, leading to a “string of bankruptcies” and a “worldwide recession.” That indeed came to pass, with consequences that the 2009 preface to this edition deals with.

Irrational Exuberance is more than ever a cogent, chilling, and astonishingly far-seeing analytical work that no one with any money in any market anywhere can afford not to read–and heed.

Editorial Reviews

Amazon.com Review

Sequels often disappoint when compared to their predecessors, but author Robert Shiller has proved the exception to the rule with his second edition of Irrational Exuberance. When the original book released in 2000, Shiller's prescient analysis of bubble-like market behavior provided perspective on the painful meltdown of stock-price valuations that subsequently occurred. Five years later, the Yale professor's bearish predictions about real-estate valuations are enough to give any savvy investor or homebuyer pause.

Shiller is one of several well-known economists and pundits who've begun a running dialogue in the last few years around the drawbacks of unchecked free markets. Few writers, though, dissect the phenomenon of bubble behavior as clearly and thoroughly as Shiller does. As with the first edition of his book, Shiller begins this one with reams of quantitative data around the late 1990s stock-market runup. This new edition adds data on real-estate price trends in the early 2000s, and points out the striking parallels between the earlier stock-market boom and bust, and current trends with housing prices in the United States. Shiller actually believes the two phenomena are related; as investors lost confidence in the stock market and moved their money into real estate, one asset class fell while the other rose. According to Shiller's analysis, the pattern is destined to repeat itself.

Aside from the initial data, the real strength of Irrational Exuberance is the straightforward, almost clinical way in which it explains why things happen as they do. The book walks readers through structural reasons for market bubbles, then ventures into "softer" analyses which professional economists less confident than Shiller would be scared to touch. It examines cultural factors behind market bubbles, such as hype-mongering news media, and psychological factors, such as herd behavior.

Another improvement in this latest edition of Shiller's book is his inclusion of more personal commentary, and he mentions the influence that his wife, herself a clinical psychologist, has had on his intellectual development and his view of psychological impacts on economic behavior. Other personal insights from Shiller center on experiences he had while touring and lecturing around the first book, and some of the most interesting passages are those in which he describes common questions or feedback from his audience, and what he thought in reaction--but didn't voice while on his tour.

In the end, Shiller closes his book with an intriguing set of policy proposals. He argues for a revamping of the U.S. social security system, a new system of house-price insurance for homeowners, and risk reduction through portfolio diversification. Fans of the brainy academic will note with approval that Shiller practices what he preaches: he has begun trying to implement some of his ideas in the real world through two private consulting firms he has founded, Macro Securities Research and Macro Financial. The hope is if Shiller's as correct with this second book as he was with his first, readers will all learn something from these new companies. --Peter Han --This text refers to the Hardcover edition.

Review

“Robert Shiller has done more than any other economist of his generation to document the less rational aspects of financial markets.” — Paul Krugman

“A modern classic of ‘serious’ economics that demands to be read, and can be enjoyed, by the interested nonspecialist.” –The Economist

“A dose of realism that serious investors will ignore at their peril.” —The Wall Street Journal

“The point of Irrational Exuberance is not to help investors dump their houses before the current exuberance fades. It is to deepen our understanding of the events we are watching as one bubble gives birth to another.” —The International Herald Tribune

“Irrational Exuberance [is] a dazzling, richly textured, provocative book . . . offering a cogent statement of the bears’ view of events to come. Shiller is not merely a bear—he is a grizzly.” —BusinessWeek

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Product Details

• Paperback: 336 pages
• Publisher: Crown Business; 2 edition (May 9, 2006)
• Language: English
• ISBN-10: 0767923634
• ISBN-13: 978-0767923637
• Product Dimensions: 6.1 x 0.7 x 9.2 inches
• Shipping Weight: 12.6 ounces (View shipping rates and policies)
• Average Customer Review: 3.9 out of 5 stars  See all reviews (45 customer reviews)
• Amazon Best Sellers Rank: #17,303 in Books (See Top 100 in Books)
  • #36 in Books > Business & Investing > Investing > Stocks
  • #66 in Books > Business & Investing > Economics > Economic Conditions

Most Helpful Customer Reviews

59 of 61 people found the following review helpful

5.0 out of 5 stars Rational Analysis October 9, 2006

By B.Sudhakar Shenoy

Format:Hardcover

I read the second edition of this book since it is enlarged with the study of the housing market. The phenomenon of bubbles and negative bubbles or collapses is described extremely well by means of statistical data of markets for over a century and a half. The raw data is adjusted to inflation to give a realistic perspective of the trends and patterns. Bubbles seem to be occurring at regular intervals typically based on the "new era" story and everyone believes at least during the heady days that good times are here to stay. But as shown by proven evidence of the past, no bubble has sustained itself permanently and good reason prevails sooner or later. When this happens, the bloated bubble collapses and the hangover is terrible. The story so far is quite simple. But what makes this book so interesting is the depth of research and the manner in which the phenomenon is studied and explained.

The combination of mass psychology and market prices is at the core of this book. For bubbles to happen, information flow is the key. Media plays a significant role in disseminating information and bubbles seem to have originated in recorded history after the advent of the print media. In recent times electronic media particularly the television and the internet play a significant role in speeding up bubble formation and also the reversals. Media needs a storyline and this story needs to be continued to retain customers on a daily basis. Stock market is the ideal place that offers an opportunity to try one's luck if a casino is far away. Backed by on-line dedicated news channels and internet trading, well, it is not surprising that we have day traders in herds. In such situations fundamentals like industry analysis and P/E ratios take a backseat as explained by the author. Historical averages are breached and a euphoria of "once in a life time opportunity" prevails. What happens to the Efficient Markets Theory in such situations?. Since this theory says that markets are perfectly priced based on all publicly available information there cannot be a situation of either under pricing or over pricing. This book perfectly challenges the efficiency and accuracy of this theory.

It is unfortunate that substantial amounts of investments meant to be otherwise risk free sources of income, pension funds for example, are getting diverted into risky markets. Here the author has come out with a list of some sound proposals to protect hard earned life long savings of innocent citizens who are exposed to the irrationality of markets.

The bubble in the housing market is also discussed well. Housing seems to be isolated bubbles occurring in specific regions and not a global phenomenon. But nevertheless the damage can be the same. The party of low interest rate regime seems to be over and a spike in mortgage rates is sure to be the needle that will prick right through this big speculative bubble.

What goes up has to come down ! But once you start reading this book, it is difficult to put it down. Intellectually stimulating and bound to be economically rewarding.

26 of 26 people found the following review helpful

5.0 out of 5 stars Schiller's prophetic book offers practical investment implications August 22, 2006

By Andrew Szabo

Format:Hardcover

About Robert J. Schiller's book, Irrational Exuberance (2000; 2nd ed., 2005), it's hard to say enough good things. First Schiller, who is Stanley B. Resor Professor of Economics at Yale University, had uncanny timing. His warning on the excesses of the technology bubble stock market came out at its very peak, in mid-March of 2000. He wrote in an afterward to the paperback edition (2001) that as he made publicity visits to bookstores in April of 2000, a large carnage had already occurred in the market, particularly for tech stocks and e-business names. Second, he writes in a transparent style. Third, he and his team, instead of tossing out opinions about what they think investors do, carry out frequent sample surveys of both individual and institutional investors. Fourth, he undergirds his hypothesis with numerous insights from economics, psychology, game theory and history. Finally, he gives many cross-references to booms and busts around the globe.

The second edition points to over-valuations in the U.S. real estate market that Schiller believes were comparable to the excesses of the dot-com era in stocks. This prediction may prove to be accurate as well, but the unraveling so far has not proceeded in so dramatic a fashion as did the technology crash.

From what valuation method does Schiller proceed his analysis of stocks? Fundamentally, he bases it on price-earnings ratios. (Price-earnings ratios have been shown to be a crucial characteristic in predicting long term stock portfolio performance; see James P. O'Shaughnessy, What Works on Wall Street [1998, rev.]). More precisely, he uses as his numerator the real (inflation-adjusted) S&P (Standard & Poor's) Composite Stock Price Index. For the denominator, he uses the moving average of the past ten years of real S&P Composite Earnings. Advantages of these data series: the source is considered reliable; they go back to 1841 continuously; they are inflation-adjusted.

Using the price-earnings data and ratio as defined above, a first great cyclical high can be seen in June 1901: a P/E ratio of 24.5 times. Subsequently, P/E declined, and stocks performed in a desultory fashion, until June of 1920. The second great peak, occurring at the end of the Roaring Twenties, was 32.6 times--reached during September of 1929. The Great Crash followed. A third peak occurred during the so-called "go-go" era of the 1960s: 24.1 times in January of 1966. This too came a cropper, followed by years of stock market underperformance--bottoming out in terms of P/E ratio in the early 1980s. The US stock market P/E ratio at the height of the technology boom in 2000 reached an unprecedented 44.3 by January of 2000. Then, boom-boom, out went the lights!

Schiller explores from many perspectives just how markets sometimes reach such giddy highs. One "amplification mechanism" is likened to a naturally occurring Ponzi process. Charles Ponzi attracted 30,000 investors and $15,000,000 within seven months during 1920. Ponzi promoted his scheme by cashing out some early investors, which excited many followers. Ponzi schemes always involve an attempt to pyramid investor inputs while wasting or defrauding much of the principal outside of the touted investment theme. Schiller points out that rapidly rising stock markets can bring in an unintended Ponzi dimension, as late-comers seek to replicate earlier investors' apparent success.

Such feedback loops lead to circles of investor behavior, which can promote the expansion of a bubble, but also can lead to its rapid deflation. Schiller also shows how news media attention to feedback loops can intensify their force and expand the volume of participation by investors. Often, behind investment fads, there are popular ideas about "new eras" that supposedly render irrelevant any historical comparisons. Feedback loops are facilitated by the demonstrated over-confidence of many individuals in their judgments as well as by evolved patterns of mass behavior.

Generally, markets threaten to become untethered whenever investors' principal focus is on price performance rather than fundamental value criteria. In such an atmosphere, it can be imagined that trees truly can grow to the sky. Or at least that there will be a "greater fool" who will take you out of your investment in a timely fashion.

Schiller does not purport to offer a rule of thumb for market trading practice. Indeed, any scheme that could be used continuously and in static form to operate a successful trading system (a putative "money machine") would surely be arbitraged away by perceptive traders. Instead, he lays out a more intuitive case for how to avoid investing in major market excesses when they occasionally occur. His proposed solutions included a salutary emphasis on hedging activities. Some of the hedges he lays out are novel but may not be practical to implement, owing to the problem of illiquidity (lack of ability to trade).

(The author of this review, Andrew Szabo, is founder of MindBodyForce.com)

15 of 16 people found the following review helpful

5.0 out of 5 stars indepth analysis on market behavior April 2, 2005

By Sreeram Ramakrishnan VINE™ VOICE

Format:Hardcover

In a welcome second edition of the book, Shiller sets up his main theses using the real estate "bubble" (or if you prefer, "boom") example. The first part of the book focuses on a historical analysis of the "bubble" scenarios and uses the recent real estate phenomenon to explain the context of his arguments. He systematically argues against all the reasons cited for the real estate boom (population, construction costs, etc.) In the second part, he focuses on causes for these speculative behaviors of investors and their changing perceptions on risk. His classification of factors into precipitating and amplifying groups is an interesting approach. He then proceeds to explain cultural, political and psychological factors to reason why he thinks investors behave in a "speculative" mode. His attack on the cable TV news media and their "noisy" coverage of business news is an amusing and thought-provoking read.

Any serious investor for the long term (and short term) will find the insights on market behavior very useful in analysing his/her own behavior. The efficient market theory, "greater fool" theory, etc. will also need a more critical look after reading Shiller's comments.

This thought provoking book is an excellent read along with Jeremy Siegel's (one of the authors friends/advisors) book which takes a much more positive perspective on market trends and more importantly, market behavior.

While the strength of the arguments will keep the reader interested, the book is no easy week-end read. It needs to be read in a slow pace to absorb the gravity of the arguments. But that shouldnt deter a serious investor. A must have.