Irrational Exuberance Book Report

Irrational Exuberance Second Edition

Robert Shiller

Scott Corcoran

Prof. Laramie

11/21/14

Irrational Exuberance Book Report

        The words irrational exuberance were first uttered by Alan Greenspan in 1996, at a black tie dinner in Washington. This immediately lead to a minimal drop in almost every financial market across the world. Shiller believes that this phenomenon of Irrational Exuberance explains why markets have been bid up so high to unstable levels under the influence of market psychology. While Greenspan made his speech in 1996 the Dow Jones had been sitting at 3,600 then the market exploded. By March 1999, it had passed 10,000 for the first time ever and by January 14th, 2000 it stood at 11,722.98. This is all seemed to be jumpstarted by the new millennium but we would shortly fall into the hangover stage some years later. But this jump was not just in the American market, we saw the real market valuation of Brazil, France, China, and Germany almost tripled in price from 1995 to 2000. The only other time where there was such a high stock price run up was back in the 1920s which lead to the Stock Market Crash in 1929. Although it is not exactly the same it is the closest measureable experience we have to compare. Then between years 2000 and 2001 the corporate profits fell severely, the biggest percentage drop since between the years 1920-1921.

        Yet there were other periods where the stock market was priced high compared to earnings and this was also at the beginning of a new century. In 1900-1901 the price relative to earnings sky rocketed to about 25.2 but that was the highest this new market had seen. There was a lot of optimism about the future and creation of all new technology. Then shortly after that it grew once again to 32.9 where shortly it fell dramatically, throwing the United States in the Great Depression. There was also the “Kennedy-Johnson Peak” where since such a charismatic leader like John Kennedy came into power it brought confidence into the mind of traders. Also after the tragedy it continued to keep people trading. But what all of these markets have in common is that they are all connected with being a bull market, which is up trending where prices are rising or expected to rise.

        Interest rates have been falling more or less since the 1982 crash, which left the stock market at rock bottom. It was widely accepted that the decline of interest rates can explain the rise in the stock market during the 1990s, then the Fed Model was adopted which was the relation between the stock market and the ten year interest rate. They later found out that this was not a good model because there is not a strong relation between interest rates and the price-earnings ratio.

        Alan Greenspan did not necessarily have the answers to the statements and question he had arisen himself. Greenspan is very careful with his words but he brought up irrational exuberance but less than a year later he was backing a “new era” type which is different from his earlier remarks. Since our most intelligent people could not even answer these questions, the public turned to find answers from the different markets, like the real estate market.