Irrational Exuberance

Deciding to wait in line for a restaurant filled with people, acting as the S&P 500 spirals downward, stock market booms, animal spirits...irrational exuberance. If a group of people trigger the result of other groups following similar action, then the action is perpetuated and grows in magnitude. Whenever I see a line for something at the front which I cannot see, I am tempted to wait in line despite not knowing what awaits me at the end. When I see a group of people sprinting towards me in fear, I am going to run with them despite having no idea what they are running away from. In the case of the housing bubble, upward spiraling home prices spurred people to purchase homes (in some cases multiple) in the hopes of selling the homes at a profit a short period of time later. This increasing demand for houses that pushed prices upward was artificial as the purchased houses were to be added to the supply soon after purchase. As this process continued for a few years, and many people were making money easily, a rumor arose among the public that real estate was recession-proof and a fool-proof investment due to the fact that people need shelter. However, the irrational exuberance of the whole episode points to the eventually stabilization of prices and the loss of available capital (perceived) to homeowners.

While at Cambridge, I still remember one of my finance professors saying: stocks are like cows. I assume he used this term not only to describe irrational exuberance of stock price fluctuations and booms, but also the implication that investors can have the brain capacity/ability of a cow when it comes to stocks.

Is it really irrational to follow mindlessly after a group? Yes, if you are in a position of having contradicting information, flexible time, a cynical state of mind, being the factor causing the movement, and a few other positions. However, it is also rational to follow mindlessly after a group if you are in a case of asymmetric information, believe that others have undergone the rationalization process, or even for the sake of just following others with the mindset that if you win, we all win, and if we lose, we all lose.

Irrational exuberance and rational movement is merely dependent on position. Behavioral finance attempts to predict certain movements and allocations; knowledge of the subject's perspective and position is crucial. Do you see the glass half full or half empty? That depends on your position, in reality and theory.

Position. Perspective. Before judging the perceived irrational exuberance, let us be partial to the factors that may not be in front of us...we must learn to be more empathetic to peoples' cases.