{"id":20314,"title":"10 Years after Lehman \u2013 Psychological Causes of a Speculative Bubble (Part 3)","link":"https:\/\/bst-europe.eu\/de\/globalization\/10-years-after-lehman-psychological-causes-of-a-speculative-bubble\/","date":"19. September 2018","date_unix":1537367020,"date_modified_unix":1584457892,"date_iso":"2018-09-19T14:23:40+00:00","content":"
\"Andrew<\/a>
Andrew Wulf \/ Unsplash \u2013 Unsplash License, https:\/\/unsplash.com\/license<\/figcaption><\/figure>\n

In the first<\/a> and second<\/a> part of the series I dealt with the monetary causes of the Lehman bankruptcy and the associated collapse of the world economy. This blog post deals with the psychological roots of these bubbles.<\/i><\/p>\n

Speculation is to a large extent a psychological phenomenon<\/h2>\n

Speculative bubbles<\/strong> have been around since people started trading assets. Almost 4 centuries ago, in 1637, the tulip imported from the Orient became a status symbol for the upper classes in the Netherlands. Tulip bulb prices skyrocketed and continued to rise until they cost as much as a high-end house. At which point, no one was willing to pay the market price. The bubble burst<\/a> – a pattern repeated over and over again since then.<\/p>\n

So why does this keep happening?<\/h2>\n

Three elements play a role in the development of a speculative bubble<\/strong><\/i>, all of which, apparently each generation needs to learn for itself.<\/p>\n

#1 Greed and envy<\/h3>\n

First of all, greed and envy can lead to a speculative bubble. When friends and neighbours in a person’s social environment have become rich by buying shares, the person wants to do the same. So he or she buys the shares – even if prices rise. This additional demand drives up the price. This behavior can quickly develop into a herd behavior<\/a>.<\/p>\n

#2 Herd behavior<\/h3>\n

If investors believe the price of a particular asset is rising, they will buy in. High demand causes prices to rise, incentivizing more people to buy. The cycle continues – prices rise and rise<\/strong>.<\/p>\n

Herd behavior is widespread among fund managers and forecasters<\/strong>. Fund managers tend to buy stocks that all other fund managers buy. Even if the share price collapses sometime later, managers don’t need to justify their decision: They only did what everyone thought was right<\/strong>. Even forecasters tend to base their forecasts on those of other forecasters, especially in times of great uncertainty<\/strong>.<\/p>\n

#3 Overconfidence<\/h3>\n

The third element that plays a role in the development of a speculative bubble<\/i>; many people are convinced they are smarter than the market<\/strong>.\u00a0 Even if market participants know that the price of a certain share is overextended, they will still enter the market as buyers, counting on finding someone to whom they can later sell at a higher price. Market participants, experienced investors and newcomers alike, believe they can „time the market“ and exit with profits<\/strong>.<\/p>\n

Can we ever neutralize the psychological elements?<\/h2>\n

More than 30 years ago, Vernon Smith started experimenting<\/a> with the behavior of people in simulated financial markets, sparking an interest in the psychology of markets <\/strong>and spawning multiple studies by economists and psychologists across the globe.\u00a0 The findings across the board:\u00a0 as soon as the number of trading phases is greater than 15 or 30, a speculative bubble occurs, which ends in a rapid and sharp drop in prices<\/strong>.\u00a0 This held true even when varying the experiment design – e.g. the introduction of a transaction tax or limitation of price fluctuations.<\/p>\n

If these psychological elements exist in human behavior, can we ever prevent the overheating of asset markets?<\/strong> We’re skeptical.<\/p>\n

Prepare for more speculative bubbles in the future.<\/p>\n

If you enjoyed reading this post you will also like the first part of our series.<\/a><\/p>\n","excerpt":"

In the first and second part of the series I dealt with the monetary causes of the Lehman bankruptcy and […]<\/p>\n","thumbnail":"https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2018\/09\/andrew-wulf-430514-unsplash-scaled.jpg","thumbnailsquare":"https:\/\/bst-europe.eu\/wp-content\/uploads\/sites\/24\/2018\/09\/andrew-wulf-430514-unsplash-scaled.jpg","authors":[{"id":312,"name":"Thie\u00df Petersen","link":"https:\/\/bst-europe.eu\/blogger\/dr-thiess-petersen\/"}],"categories":[{"id":152,"name":"Globalization","link":"https:\/\/bst-europe.eu\/category\/globalization\/"}],"tags":[]}