Irrational Exuberance

Financial Management (UK), March, 2006 by Mike Brooks

IRRATIONAL EXUBERANCE Author: Robert Shiller Publisher: Princeton University Press Price: 17.95 [pounds sterling] ISBN: 0691123357

The title refers to a comment by Alan Greenspan, the former chairman of the US Federal Reserve, in a speech to the American Enterprise Institute in December 1996. He was alluding to the difficulties of relating the prolonged increase in equity prices to any real change in business fundamentals and went on to warn of the dangers to the world economy of a sudden reversal resulting from this trend.

This second edition is a timely update of Robert Shiller's bestseller, first published in 2000 just as the US stock market was about to go over the edge. Shiller is professor of economics at Yale and, while his book has all the rigour that one might expect from a leading academic, it is accessible. It follows a logical structure and leads the reader through the arguments in a clear--and often entertaining--manner.

Starting with a historical summary of share and property price movements, Shiller describes the factors that led to the stock market boom of the late nineties and warns of the dangers of believing in "new eras". More important, he discusses what he refers to as amplifying mechanisms: self-reinforcing processes that tend to drive markets to heights that cannot be justified by underlying economic realities.

These mechanisms have both cultural and psychological roots, and he provides a fascinating insight into how investors seem powerless to prevent them, even when they know what's happening. Shiller demonstrates the frailty of the "efficient markets" hypothesis that underpins much current academic finance theory. He concludes by proposing that governments should seek to eliminate some of the more obvious weaknesses of the world's financial systems.

Overall, I can heartily recommended this book to anyone who really wants to understand the factors behind stock market and property bubbles.

Mike Brooks FCMA, business writer and consultant.