[2009-02-19] “Irrational Exuberance”

Robert Shiller (of the Case-Shiller housing index fame) is one of the few level-headed economists who have been able to recognise and point out market bubbles in the making and who have had the courage to stand by their analyses even in the face of ridicule. His book “Irrational Exuberance” became famous for calling out the stock-market bubble in the US when it was published in early 2000, just some time before the bubble burst. The second edition of the book has again been remarkable for pointing out the housing-market bubble in the US when it was published in 2005, though this time it took a little over a year since then for the bubble to burst.

The book starts off by providing a historical perspective of the stock market and the housing market in various cities. It then examines the structural, cultural and psychological factors that result in market bubbles, followed by some of rationalisations that people usually resort to when they find themselves in the midst of such bubbles. It ends with examining the ways in which influential people can prevent such bubbles from forming and hurting a lot of people when they burst.

The author has been able to strike a fine balance between academic rigour and prose interesting to the lay person. Almost all the assertions are backed by the relevant data, method of collection, references, etc. There are quite a few endnotes in the book for each chapter so that the serious reader can get more details. At the same time, an intelligent non-economist should also be able to follow and appreciate most of the arguments in this book. This is a rare accomplishment.

If you believe in the efficient market hypothesis or that stocks are always good investments for the long run or that real-estate is a sure way of significant capital appreciation, you must read this book and consider the arguments and data provided here. If you were already sceptical of one or more of these theories, you will obtain substantial ammunition here for your debates with people who believe otherwise. The author provides cogent arguments against each of these beliefs that have now become a part of conventional wisdom.

The book is somewhat biased towards examining the irrational expectations that people have from the stock market. The book talks about the housing market in detail only in the beginning and in the end. I would have preferred a more uniform treatment of the two.

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