Book SummaryIrrational Exuberance, by Robert J. Shiller

1-Page Summary1-Page Book Summary of Irrational Exuberance

According to Nobel laureate economist Robert J. Shiller, mainstream economists’ faith in efficient markets is wildly misguided. Shiller argues that financial markets are rife with speculation, meaning that investors often drive prices far beyond their fair value. In Irrational Exuberance, Shiller contends that speculative bubbles pervade financial markets and outlines his theory of the structural, cultural, and psychological considerations that create and sustain these bubbles.

Irrational Exuberance was originally published in 2000 and focused mainly on the dotcom bubble of the 1990s. In 2005, Shiller published a second edition that contained additional discussions of the housing bubble that was growing at that time. Our guide is based on the book’s third edition, which was...

Irrational Exuberance Summary Speculative Bubbles in Investing Markets

To understand Shiller’s account of speculative bubbles, we need to understand what these bubbles are in the first place. Shiller explains that speculative bubbles arise whenever news about an asset’s price increase generates further price increases as investors learn about the initial increase and become overly optimistic. These subsequent increases are a byproduct of investors’ zeal about previous increases rather than a result of concrete information about the asset’s true value.

(Shortform note: According to economist Hyman Minsky, the lifespan of speculative bubbles has five key stages. First, investors become optimistic because of some financial development, such as a new product release. Then, prices start to rise as more people invest to avoid missing the boom. Afterward, momentum carries prices even higher, and some investors decide to cash out because they believe the bubble is about to burst. Finally, other investors begin to panic as the price begins to drop, spurring widespread selling that effectively bursts the bubble.)

In this section, we’ll dig deeper into Shiller’s rationale...

Irrational Exuberance Summary Irrational Exuberance as the Foundation of Speculative Bubbles

Having laid out his case that speculative bubbles do exist, Shiller then turns toward the origins of these bubbles. In this section, we’ll discuss Shiller’s theory of speculative bubbles and examine the structural components that enable them to arise, the cultural components that enable them to grow, and the psychological components that restrict them from growing indefinitely.

The Foundation of Speculative Bubbles

According to Shiller, speculative bubbles are made possible by feedback loops. He argues that feedback loops in investing markets reinforce the price changes caused by new financial information, leading to disproportionate price increases. To illustrate, he examines the dotcom boom of 2000.

How Feedback Loops Create Speculative Bubbles

Shiller writes that when relevant information drives a security’s price higher, that price increase itself often spurs further price increases, creating a feedback loop. These loops, he explains, can occur for various reasons. For example, if investors learn that Netflix’s stock has risen consistently over the past year, they might expect further increases going forward, leading them to purchase more Netflix...

Irrational Exuberance Summary How to Mitigate Speculative Bubbles

Having not only shown that speculative bubbles exist, but also how structural, cultural, and psychological elements give rise to and sustain these bubbles, Shiller proceeds to discuss what we can do to mitigate speculative bubbles. In this section, we’ll briefly examine Shiller’s advice for financial leaders and the general public to curb speculation in financial markets.

Shiller’s Advice for Financial Leaders and the Public

Although there’s no foolproof way to prevent speculative bubbles from taking root, Shiller maintains that financial leaders and the public can take steps to limit speculation. He argues that financial leaders should speak openly when they think the market is overpriced, and the public should diversify their portfolios to prevent prices in certain markets from rising irrationally.

Schiller writes that, when key financial figures voice candid views about financial markets, it can help the market remain steady and avoid speculative bubbles in either direction. For example, when influential financial leaders voice suspicions that the market is overpriced, that can curb investors’ enthusiasm and pre-empt further speculative trading. By contrast, when...

Shortform Exercise: Assess Speculation in Different Asset Classes

Shiller suggests that speculation has influenced pricing in several different asset classes, namely stocks, bonds, and housing. In this exercise, evaluate Shiller’s arguments and reflect on speculative bubbles in your own country.

Of the three asset classes that Shiller discusses (stocks, bonds, and housing), which do you think is most clearly susceptible to speculation at the moment? Why?