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History, Stories, and
Amplification Mechanisms
Fin254f: Spring 2010
Lecture notes 2.5
Readings: Shiller 3-7
What is this Section About?
 Shiller's
qualitative takes on financial
bubbles
 How do they get started?
 What makes them really take off?
 What mechanisms contribute?
Outline
 Precipitating
factors in the late 20th
century
 Amplification mechanisms
 The media
 New era thinking
Precipitating Factors
Mostly in the 80's and 90's
 Capitalist
explosion
 Cultural changes toward business
 New information technologies
 Supportive monetary policy
 The baby boom and bust
 Business news reporting
 Analysts optimism
Precipitating Factors
Mostly in the 80's and 90's
 Institutional


investment changes
Defined contribution pensions (mutual
funds)
Hedge funds
 Low
inflation
 High frequency trading
 Gambling opportunities
Capitalist Explosion and
Ownership Society
 Increase
in market organized
economies
 Labor union declines (1983: 20.1% 2000:13.5%)
 Employee stock option plans

Greater fixation on stock prices
Cultural Changes Favoring
Business
 More
materialistic measures of worth
 Cuts in tax rates
 Greater acceptance of large salaries
 (Is this all changing?)
New Information Technology
Cell phones (1982)
 Internet (military -> academic -> everyone)
 Earnings growth: 1994 +36%, 8 in 1995, and
10 in 1996




Probably not internet
How much should a new technology effect existing
firms?
Remember, what matters is public perception
Monetary Policy and the
Greenspan Put
 No
moves to tighten monetary policy in
the 90's


Interesting given irrational exuberance
speech
Several events where liquidity provided
(LTCM, Y2K)
 Also,
did the Fed lower rates too much
in 2003?
Baby Boom and Baby Bust
 Baby
boomers save and drive up stock
market


Saving bulge : demographic
Generation forgets depression
 Problems:


What about when and how they sell?
What about global demographics?
 www.hsdent.com
Expansion of Media Coverage
 CNBC,
CNNfn, Bloomberg TV
 Business news gets "glitzier"
 Stock tip shows (Cramer)
Analyst Forecasts
 Overly
optimistic (in 1999 only 1% sell)
 Analyst problems



Employed by investment banks
(underwriting)
Might lose info contacts at firms they rate
negatively
Employed by brokers : interest in volume
 Some
regulatory reform around 2000
Expansion of Defined
Contribution Pension Plans
Defined Benefit versus Defined Contribution
 Less costly to firms
 Better for mobile workers
 Generates more public attention to stocks
 How well do people diversity?




Bernartzi/Thaler on what people do
Equal weight in stock and bond funds
and in stock and stock/bond funds
Growth of Mutual Funds
 1982:
340, 1998: 3513
 More equity mutual funds than stocks
on NYSE
 Start in 1920's
 Public perception rises and falls
 Part of 401K investments
 Currently seem ok, and draws more
attention to markets
Decline of Inflation
 Lower
inflation -> Public confidence
 Money illusion



Most price series reported in nominal terms
Reporters think inflation too complicated
and no one cares
Makes a big difference, two examples
U.S. stocks in the 1970's
 Long term home price series

Online Trading
 Etrade


and daytrading (internet)
Turnover rates double between 82-99
Lower transactions costs
 Does
this impact a bubble?
Gambling Opportunities
 Rise
of state lotteries
 Increase in casinos
 Changes attitudes toward risk
 Can this spill into the stock market?
Amplification Mechanisms
 Confidence
 Feedback
Shiller Surveys
 "The
stock market is the best
investment for long-term holders, who
can just buy and hold through the ups
and downs of the market."
 2000: 97% at least somewhat agree
 2004: 83%
Shiller: Real estate as Long
Term Investment
 See
table
Forecasts of Returns: Dow
 1989:
0%
 1996: 4.1%
 2000: 6.7%
 2001: 8.4%
 2004: 6.4%
Confidence Levels Again
 See
figure 4.1
 Fraction thinking market is over valued
 Compare institutional and individual
investors
How do People Process
Data?
 Recent
and distant past
 Memory
Feedback
 Price
-> Buy -> Price -> Buy
 Price -> GDP -> Price -> GDP
 Can we model this?
More on Ponzi
 Basic



 In



parts
Plausible stories
High returns
Early success : start slow, ramp up
stocks
Story: exaggerated, but not a lie
Early price manipulation
Draw in crowd
Real Estate and the Stock
Market
 Stock

market
"Had no effect on my decision to buy a
house" : 72% in 2003-4
News Media

Record overload

Superlatives (record everyday)
Stock market moves and big news
 Tag along news


News tags along as an "explanation" for price
moves
Crashes of 29 and 87
 New media outlets and rumors


Internet sites
29 in Press

Crash of 29: October 28-29



NYT(29 AM): "general loss of confidence"
WSJ(29 AM): "necessitous liquidation of impaired
accounts"
President Hoover develops inland waterways
Some news on Smoot-Hawley tariffs, but
could that be so big?
 Black Thursday, October 24, 1929



Market falls by 12.9%, but then recovers
No real big stories
October 28th/29th 1929
-12.3% and –11.3%
“general loss of confidence
in the market and the inability
of any man or group to stem
such a torrent of selling.”
October 19, 1987 in the Press
 Shiller


survey
10 news stories
Most important: story about past price
declines
 Higher
than expected trade deficit,
possible tax changes
 Fires off computerized sell programs
(negative feedback)
October 19, 1987
-20.5%
“Worry over dollar and trade deficit”
Feedback Again

Leverage




Price falls
Borrowed fraction increases
Sell off some (deleverage) -> price falls
Short selling



Price rise
Value of "borrowed" stock increases
Need to buy some back to reduce borrowing - >
price rise
New Eras


“New economy”
1901


1920’s



Trains, electricity, new century
Electricity, mass production, prohibition
Irving Fisher
50’s and 60’s

Baby boom, computers, credit cards, macroeconomic policy
New Eras
 90’s





Globalization
Technology
Low inflation (macro policy again)
Profits
Productivity
Global New Eras
 Largest


See table 7.1
See also subsequent year patterns
 Largest

1 year decreases
See table 7.2
 Largest

1 year stock market increases
5 year increases
See table 7.3
Stories
 Philippines:
Dec85-86: +683%, Marcos
regime collapses. Aquino takes over.
Avoids messy civil war.
 Taiwan: Oct86-87, +400%, booming
exports, double digit growth, shifting to
high tech goods, P/E ratios to 45,
gambling frenzy, eventually declines by
79% (89-90)
More Stories
 Venezuela:
90-91 +384%, recovering
economy, oil market uncertainty (Gulf
War I), eventually prices fall by 82%
 India: April 91-92, +155%, begins large
scale deregulation, opens to foreign
investment, some price manipulation
maybe, falls by -50% next year
Reversals
 Do
most stock increases reverse?
 If true, big deviation from random walk.
 68% of 5 year winners see price decline
in next 5 years
 80% of 5 year losers see price increase
in next 5 years
Outline
 Precipitating
factors in the late 20th
century
 Amplification mechanisms
 The media
 New era thinking
Summary
 Stories
 Amplifications


Price feedback
News
 Global


mechanisms
info
Stock market increases (bubbles) common
Most reverse