History and stories
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History, Stories, and Amplification Mechanisms Fin254f: Spring 2010 Lecture notes 2.5 Readings: Shiller 3-7
What is this Section About? Shiller's
qualitative takes on financial
bubbles How do they get started? What makes them really take off? What mechanisms contribute?
Outline Precipitating
factors in the late 20th
century Amplification mechanisms The media New era thinking
Precipitating Factors Mostly in the 80's and 90's Capitalist
explosion Cultural changes toward business New information technologies Supportive monetary policy The baby boom and bust Business news reporting Analysts optimism
Precipitating Factors Mostly in the 80's and 90's Institutional
investment changes
Defined contribution pensions (mutual funds) Hedge funds
Low
inflation High frequency trading Gambling opportunities
Capitalist Explosion and Ownership Society Increase
in market organized economies Labor union declines (1983: 20.1% 2000:13.5%) Employee stock option plans
Greater fixation on stock prices
Cultural Changes Favoring Business More
materialistic measures of worth Cuts in tax rates Greater acceptance of large salaries (Is this all changing?)
New Information Technology Cell phones (1982) Internet (military -> academic -> everyone) Earnings growth: 1994 +36%, 8 in 1995, and 10 in 1996
Probably not internet How much should a new technology effect existing firms?
Remember, what matters is public perception
Monetary Policy and the Greenspan Put No
moves to tighten monetary policy in the 90's
Interesting given irrational exuberance speech Several events where liquidity provided (LTCM, Y2K)
Also,
did the Fed lower rates too much in 2003?
Baby Boom and Baby Bust Baby
boomers save and drive up stock market
Saving bulge : demographic Generation forgets depression
Problems:
What about when and how they sell? What about global demographics?
www.hsdent.com
Expansion of Media Coverage CNBC,
CNNfn, Bloomberg TV Business news gets "glitzier" Stock tip shows (Cramer)
Analyst Forecasts Overly
optimistic (in 1999 only 1% sell) Analyst problems
Employed by investment banks (underwriting) Might lose info contacts at firms they rate negatively Employed by brokers : interest in volume
Some
regulatory reform around 2000
Expansion of Defined Contribution Pension Plans Defined Benefit versus Defined Contribution Less costly to firms Better for mobile workers Generates more public attention to stocks How well do people diversity?
Bernartzi/Thaler on what people do Equal weight in stock and bond funds and in stock and stock/bond funds
Growth of Mutual Funds 1982:
340, 1998: 3513 More equity mutual funds than stocks on NYSE Start in 1920's Public perception rises and falls Part of 401K investments Currently seem ok, and draws more attention to markets
Decline of Inflation Lower
inflation -> Public confidence Money illusion
Most price series reported in nominal terms Reporters think inflation too complicated and no one cares Makes a big difference, two examples U.S. stocks in the 1970's Long term home price series
Online Trading Etrade
and daytrading (internet)
Turnover rates double between 82-99 Lower transactions costs
Does
this impact a bubble?
Gambling Opportunities Rise
of state lotteries Increase in casinos Changes attitudes toward risk Can this spill into the stock market?
Amplification Mechanisms Confidence Feedback
Shiller Surveys "The
stock market is the best investment for long-term holders, who can just buy and hold through the ups and downs of the market." 2000: 97% at least somewhat agree 2004: 83%
Shiller: Real estate as Long Term Investment See
table
Forecasts of Returns: Dow 1989:
0% 1996: 4.1% 2000: 6.7% 2001: 8.4% 2004: 6.4%
Confidence Levels Again See
figure 4.1 Fraction thinking market is over valued Compare institutional and individual investors
How do People Process Data? Recent
and distant past Memory
Feedback Price
-> Buy -> Price -> Buy Price -> GDP -> Price -> GDP Can we model this?
More on Ponzi Basic
In
parts
Plausible stories High returns Early success : start slow, ramp up
stocks Story: exaggerated, but not a lie Early price manipulation Draw in crowd
Real Estate and the Stock Market Stock
market
"Had no effect on my decision to buy a house" : 72% in 2003-4
News Media
Record overload
Superlatives (record everyday)
Stock market moves and big news Tag along news
News tags along as an "explanation" for price moves
Crashes of 29 and 87 New media outlets and rumors
Internet sites
29 in Press
Crash of 29: October 28-29
NYT(29 AM): "general loss of confidence" WSJ(29 AM): "necessitous liquidation of impaired accounts" President Hoover develops inland waterways
Some news on Smoot-Hawley tariffs, but could that be so big? Black Thursday, October 24, 1929
Market falls by 12.9%, but then recovers
No real big stories
October 28th/29th 1929 -12.3% and –11.3% “general loss of confidence in the market and the inability of any man or group to stem such a torrent of selling.”
October 19, 1987 in the Press Shiller
survey
10 news stories Most important: story about past price declines
Higher
than expected trade deficit, possible tax changes Fires off computerized sell programs (negative feedback)
October 19, 1987 -20.5% “Worry over dollar and trade deficit”
Feedback Again
Leverage
Price falls Borrowed fraction increases Sell off some (deleverage) -> price falls
Short selling
Price rise Value of "borrowed" stock increases Need to buy some back to reduce borrowing - > price rise
New Eras
“New economy” 1901
1920’s
Trains, electricity, new century
Electricity, mass production, prohibition Irving Fisher
50’s and 60’s
Baby boom, computers, credit cards, macroeconomic policy
New Eras 90’s
Globalization Technology Low inflation (macro policy again) Profits Productivity
Global New Eras Largest
See table 7.1 See also subsequent year patterns
Largest
1 year decreases
See table 7.2
Largest
1 year stock market increases
5 year increases
See table 7.3
Stories Philippines:
Dec85-86: +683%, Marcos regime collapses. Aquino takes over. Avoids messy civil war. Taiwan: Oct86-87, +400%, booming exports, double digit growth, shifting to high tech goods, P/E ratios to 45, gambling frenzy, eventually declines by 79% (89-90)
More Stories Venezuela:
90-91 +384%, recovering economy, oil market uncertainty (Gulf War I), eventually prices fall by 82% India: April 91-92, +155%, begins large scale deregulation, opens to foreign investment, some price manipulation maybe, falls by -50% next year
Reversals Do
most stock increases reverse? If true, big deviation from random walk. 68% of 5 year winners see price decline in next 5 years 80% of 5 year losers see price increase in next 5 years
Outline Precipitating
factors in the late 20th
century Amplification mechanisms The media New era thinking
Summary Stories Amplifications
Price feedback News
Global
mechanisms
info
Stock market increases (bubbles) common Most reverse
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