## Bubbles and Fads in Asset Prices (1989)

Venue: | Journal of Economic Surveys |

Citations: | 30 - 0 self |

### BibTeX

@ARTICLE{Camerer89bubblesand,

author = {Colin Camerer},

title = {Bubbles and Fads in Asset Prices},

journal = {Journal of Economic Surveys},

year = {1989},

pages = {3--41}

}

### OpenURL

### Abstract

Abslract. The article considers the possibility that asset prices might deviate from intrinsic values based on market fundamentals. Three broad categories of theory are surveyed: (a) growing bubbles (b) fads and (c) information bubbles. 'Sunspot' theories are also discussed. The paper covers both theory and evidence, and directions for future research are discussed.

### Citations

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Citation Context ...lson, 1965). Rationality of prices therefore implies unpredicrabilitv of price changes; the studies of 'marker efficiency' rhat Kleidon alluded ro do provide ample evidence of unpredictabiliry (e.g., =-=Fama, 1970-=-, 1976). However, unpredictability does nor necessarily imply rarionality. Prices could be unpredictable if atl information is incorporated in prices and prices are affected by an unpredictable fad co... |

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Citation Context ... unreliable because of the growing regressor problem.) Because of the statistical problem associated with direct estimates of explosive bubbles, West (1987) devised a robust specification test (as in =-=Hausman, 1978-=-).BUBBLES AND FADS IN ASSET PRICES l3 Roughly speaking, west uses instrumental variables to rate r in Pt = (P,,r * D,*t)/(l + r) + ut*t estimate rhe discounr (4) where P and D are stock prices and di... |

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Citation Context ...or her prohts to be negative (event though total profits must be negarive). Even without optimism, near-rational bubbles might occur if the limits on the scope of the market are not common knowledge (=-=Aumann, 1976-=-). (By analogy, in some finitely-repeated games backward induction rules our cerrain srraregies as suboptimal if the game is commonly-known, but a lack of common knowledge can make those strategies ra... |

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Citation Context ...l98l; Michener, 1982; Flood, Hodrick and Kaplan, 1986b). Grossman and Shiller (1981) addressed this problem by correcting discount rates for risk-aversion, using a specific model of consumprion risk (=-=Breeden, 1979-=-). (They effectively tested a specific model of returns fads.) After their correction, the perfect foresight price series pI is indeed closer to the stock price series pr until 1950, but after 1950 pt... |

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Citation Context ... of expectations forces E(P,*tl I,*r) to be EIE(D.*zllt*r)* E(P,*zll,*r)ll')l/(l +r) (by extending equation (l) to prices in period r + I and taking an expectation). The law of iterated expectations (=-=Sargent, 1979-=-, pp. 208,213) reduces E(E(P,*zl t,*,; | /,) to E(P,.2I /,). Define a lag operator L, such that L(X,'l= X,-r and L-I (X,)= X,,r. Then the rational expectation condition is a difference cquation, E(Pr+... |

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Citation Context ... CAMERER if prices are rational estimates of theperfect foresight price. (Marsh and Merton. 1986, showed that (9) is always violated for a non-stationary managerial smoothing model of dividends as in =-=Lintner, 1956-=-, assuming the terminal pl is set equal to the final price p,.) Whether dividends are stationary or not is thus a crucial empirical question, which is controversial and unresolved. tt But even if divi... |

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Citation Context ...ilityrT (including trading abilityts). Optimism may be near-rational if it has psychological or biological value (Tiger, t980; Alloy and Abramson, 1979) or if people simply prefer optimistic beliefs (=-=Akerlof and Dickens, 1982-=-). Optimismt0 CAMERER among a finite number of traders could cause a 'near-rarional' bubble if each trader who remains after the first trader departs does not expect his or her prohts to be negative ... |

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Citation Context ...standing urility fads (e.g., Douglas and Isherwood, 1978); social and cognirive psychology for belief fads (e.g., Schachter etal, 1985b); and the psychology of rime preference for returns fads (e.9., =-=Loewenstein, 1987-=-).BUBBLES AND FADS IN ASSET PRICES JJ 27. Recall from basic statistics that sample variances alrvavs underesrimare true population variances. hence the iamiliar need to divide by n - I rather than n ... |

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Citation Context ... be. Markets may never be complete enough to rule out sunspots because it is diftcult to introduce enough contingent claims to span all the random events people might think are important (Cass, 1984; =-=Azariadis, 1981-=-, p.394). Even if contingent claims markets are complete, Cass and Shell (1983) note that sunspots can maler if agents have different beliefs about the prior probability of sunspots. Sunspor theories ... |

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Citation Context ...e (9) to test the discounted dividend theory of stock prices, the expectations theory of interest rate term structure (do long-term bond returns equal the geometric average of short-rerm returns? see =-=Shiller, 1979-=-; Singleton, 1980), theories relating preferred stock dividend yields and interest rates (Amsler, 1980) and foreign exchange rates and money stock differentials (Huang, l98l; Meese and Singleton, l98l... |

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(Show Context)
Citation Context ...fact that they have been allowed to hold the asset (or win rhe auction), and revised downward.re But this error seems to be difhcult to unlearn: the winner's curse does not disappear with experience (=-=Kagel and Levin, 1986-=-). Near-rational'greater fool bubbles', caused by the same error as the winner,s curse, might therefore persist when the limits of the market (or traders' rationality, Arrow, 1982), are not commonly k... |

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(Show Context)
Citation Context ...wealth or number of traders. Fads are mean-reverting deviations from intrinsic value caused by social or psychological forces like those that cause fashions in political beliefs or consumption goods (=-=Shiller, 1984-=-), or like Keynes's'animal spirits'. If fads are slowly mean-reverting, they are 'near-rational' since traders u'ould have to wait a long time to exploit their knowledge that prices are in a fad. Info... |

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(Show Context)
Citation Context ...d out. For instance, if E(Prl lt-t) is simply equal to P,-2, it is easy to show thar prices will converge to the discounted dividend level, for any value of the initial expecration E(P1//o) (see also =-=Lucas, 1986-=-). Burmeister (19g0) made the dual argument that adaptiveness in price adjustment, instead of adaptiveness in expectation adjustment, will preclude divergent paths in macroeconomic models.CAMERER 2.2... |

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(Show Context)
Citation Context ...onstant terms which arise in solutions to difference equations that govern equilibrium prices. Such bubbles can occur even when traders act rationally and have rational expectations (e.g. Hahn, t966; =-=Blanchard and Watson, 1982-=-; Tirole, 1982, 1985), unless a market is known to be limited by asset life, or by the wealth or number of traders. Fads are mean-reverting deviations from intrinsic value caused by social or psycholo... |

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(Show Context)
Citation Context ... showed that if a 590 discount rate is used, results as extreme as Shiller's could be obtained 4090 of the time; with a 6.590 rate (as in Shiller l98la), extreme results could occur l59o of the time (=-=Kleidon, 1986-=-b, p. 5486: Shiller, 1986b, p. 502). Since the exrremiry of the findings could conceivably be accounted for by nonstationariry, whether dividends are non-stationary remains an important question. (4) ... |

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Citation Context ...frrst to rhoroughty formalize the possibiliry of growing bubbles, noting that dynamic models of the price level could have indeterminate explosive solutions even if agents have rational expecrations (=-=Samuelson, 1958-=-; Hahn, 1966; Sargenr and Wallace, l973a,b; Brock, 1g74, 1975: Black, 1974; Calvo, 1978; Wallace, l9g0; Diba and Grossman, l9gga, and see Shiller, 1978, for a review). Explosive solutions are consider... |

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(Show Context)
Citation Context ...dents (Svenson, l98l). In economics experiments where subjects were paid several dollars if rhey predicted their rank in trading profits correctly, 9090 guessed rhey were in rhe rop 50go in earnings (=-=Camerer, 1987-=-). Holding the asset or winning the auction informs traders that they have higher values of ?"i(or %) than other people, and they should revise their esrimares downward ro account for the information ... |

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Citation Context ...s dividend series is stationary, since a regression of log dividends against lagged log dividends and a time variable yielded a coetficient estimate of 0.807 (see also Blanchard and Watson. 1982. and =-=West, 1988-=-). But Kleidon (1986c) accepred rhe hypothesis of non-stationarity, using only data from 1926 on because of concerns about errors in older data. and Marsh and Merton (1987) concluded rhat a nonstation... |

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Speculative Bubbles, Crashes and Rational Expectations
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(Show Context)
Citation Context ...le could be expected to burst with probability p each period, as long as the bubble in period r+ [, conditional on not bursting , is (l + r\B,l(l - p) so that the expected growth rate is still r (see =-=Blanchard, 1979-=-; Blanchard and Watson, 1982).6 The probability that a stochastic bubble lives n periods is (l - p)'. This probability converges to zero as n grows large, so bubbles can exist even though rational tra... |

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(Show Context)
Citation Context ... are that several new directions will prove useful: theories of near-rational fads or bubbles (which are sensible but nor fully rational); data from assets other than stocks and bonds (on housing see =-=Case and Shiller, 1988-=-, in press); more study of non-price data, especially trading volume; and more data from experiments in which intrinsic values and discounr rares are controlled. Acknowledgements Thanks to Andy Daughe... |

38 |
Risk perception in psychology and economics
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(Show Context)
Citation Context ...xperience (Kagel and Levin, 1986). Near-rational'greater fool bubbles', caused by the same error as the winner,s curse, might therefore persist when the limits of the market (or traders' rationality, =-=Arrow, 1982-=-), are not commonly known. Allen and Gorton (1988) provide an interesting example of how a lack of common knowledge about a market limit can allow rational bubbles. In their simple model, it is common... |

36 | A Simple Perfect Foresight Monetary Model - Brock - 1975 |

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Testing for Bubbles in Exchange Markets: A Case of Sparkling Rates
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(Show Context)
Citation Context ...differences to make the time series of market fundamentals stationary, then if prices contain a bubble the price series will still be non-starionary when differenced Ntimes. (However, euah, 19g5, and =-=Meese, 1986-=-' Table l, showed that a stochastic bubble can look starionary so rhe differencing test will not detect stochasric bubbles.) Diba and Grossman (1985) found that stock prices and dividends were both st... |

26 | Conditions for Unique Solutions in Stochastic Macroeconomic Models with Rational Expectations - Taylor - 1977 |

24 | Business Cycles and the Behavior of Metal Prices - Fama, French - 1988 |