Irrational exuberance

Irrational Exuberance by Robert J. Shiller

I just spent some hours reading this book about behavioral finance. It’s quite a good read if you have not been exposed to the topic before. It discusses how we get into these “bubble” scenarios in financial and other markets such as real estate. For me, it was really a summary of the rather obvious things that we can see by just looking at what goes on in the world around us. If you have not been exposed to this material before, it’s a must read.

One of the areas discussed is crowd psychology. In particular, that we are followers and that we’ll do that without very much thought. For example, you’re looking for a restaurant. You’ll see one packed with people and the other empty. Now the empty one might just be empty for a number of reasons unrelated to the quality or price of the food served. The restaurant that is packed may just be the star restaurant of the moment. But people will avoid the empty one and continue to fill the full one. The author doesn’t discuss how this situation gets remedied but just mentions how people behave.

The chapters discuss other examples of crowd psychology from a finance perspective. Where I find the book falls short is taking the next step. How do we use this information to modify our behavior when we invest, say, in real estate or the stock market? I often find that many of these authors are really good at describing the “what” but fall short is dealing with the “how”.

Notwithstanding these comments, if you want to start looking at the topic of behavioral finance, this book is a good place to begin your education.