Revised and Expanded Third Edition - Irrational Exuberance

Well written but the solutions offered rely on government which has a poor track record of providing real solutions . I would have hoped for more specific suggestions for a 72 year old couple with a small business to reduce risks in stock and bond markets using index funds and asset allocation. Worth a read to make one aware of the realities which lie ahead.

I liked the honest opinion of Mr. Shiller. I agree that the stock market does not do well after a peak for a decade or so. Investing is like climbing a mountain. The guy who has all the formulas does not always reach the top. Determined person does. This book suggests buying stocks during recession and staying put for long term until you reach retirement. Reduce buying stocks when the cape ratio is high as suggested in this book. Investment professionals and media have their own self interest so turn them off and go on vacation when markets are overpriced! Great book!

I read the 1st edition of this book, by Princeton University Press, and I think Robert Shiller did a great job at the time of publication. Everybody was dazzled by the impressive performance of the market, and nobody would dare to be against it, none but Dr. Robert Shiller did! I revised the interview he held with the journalist George Will, and it is shameful seeing that Shiller's job, in that moment was not recognized as it should be, but we should know that predicting is fortune tellers' job, and Shiller is no fortune teller... he is a common sensical and brilliant academic.

Shiller makes a complex subject clear & easy to understand. His insights into what makes the economy tick are well documented making this both a fascinating read as well as highly informative for a 'non-economist'.

The discussion attempts to find objective data and models for investing in the market. It ends up being a discussion of emotion. Nowhere does the author attempt how select promising stocks or funds. As the title states investors, pro or amateur, are reactive to the news, which is selective in its reporting.

If you are looking to understand the real estate market, this book is fantastic.

If you want to learn about mean reversion, this book is very good.

For stock market information, this book is good but not great.

When I read the first edition six years ago, I loved it and read it with the cap off the highlighter most of the time. I read the second edition recently and enjoyed it again.

He is brilliant and the book is easy to read.

While all opinions on stock prices are of interest to me, this book wandered through a number of ideas and left me unconvinced of many arguments. Significant assumptions are made that are not universally accepted. For example the most important value in a stock is it's dividend.

Another idea was that experts are better judges of stock market value. In other places Dr Schiller say the public is too easily influenced by experts. One theory that he tries to debunk is the efficient market theory. My feeling is this is long gone and need no further arguments. Unfortunately this is the last most popular theory proposed by experts.

I did not like the format of continually referring to the 1st and 2nd edition that I had not read in sequence. The very informational charts and graphs were condensed too much to fit the pages in the text (3rd Edition) or the book to be any value without a painstaking view from a magnifying glass. The author's web site backup for this statistical information is a valuable courtesy, but going back and forth for data is very time consuming and not practical when you are reading without a computer nearby. Sorry!

This book held my interest throughout most of the first 250 pages or so, but it's tough reading for those who are not fans of economics and the stock or real estate markets. I have an MBA and was in corporate finance all my working life so I have an interest in research in the financial markets. The last third of the book was filled with reference materials, that to me would only be of interest to those who want to do research in the markets or in human behavior.

Generally speaking this book gives some useful information that you can apply into your analysis but the biggest part of it is just some polls , assumptions and conclusions done by the author that are not applicative for the average investor.

It's a good book. Schiller talks about behavioral economics and how this affects the modern approach in economics investigation. Unfortunately the book has such a bias against markets that looks like government has no role in crises at all. Of course his political advises are strongly biased in this direction.

If you ignore some things and learn what is really true, can be a good experience.

I read this book because other people into finance seemed to think that it was a classic. After reading a chapter or two, I found the book completely unreadable as Shiller pours statistics and graphs into the text with very little effort focused on transitions and explanations. If you understand that sometimes the stock market, or any asset class, tends to progressively become over-valued as time goes on, this book is an unnecessary read.

Just like "location, location" is the mantra in real estate investing, so it is with stock investing. To the people in 1920's the handful of companies of the DOW JONES INDUSTRIAL must have seemed as high tech and amazing as the internet companies of the 1990's; it's not a big surprise that by 1950 they no longer seem very interesting and thus were flat and went into negatives since. However the better barometer for the economy is the S&P which is what finance professionals refer to as the market index has been increasing really steadily since 1950 except for the recent giant gyrations of the past two decades.

I don't understand why he didn't do the statistics on the S&P which finance professionals all over agree is the better index to use. I understand the author is an economist and good with numbers but I've spent hours on this and have yet to find predictive values for knowing when the market is in a bubble. the author does make interesting historical and social observations, at times some commentary on the capitalist society, which is kind of not what I signed up for to read about.

Narration is highly appreciated,chartes and explanations are almost invisible from kindle.Whose responsible is not explained rather it seems nobody is exuberant even the speculators who want sell high and buy again low.Advised to make further research about ownership of stakes...

Honestly speaking, there is not much additional material in the third edition. The author has included his Nobel Prize lecture together with and some smaller additions. All the charts are updated, but they are continuously updated on his webpage anyway. The academic references and so on has not really been updated, so that makes the book somewhat dated.

If you have not read the earlier editions, this is a must read book. Furthermore, some books are worth rereading. So if you bought the second edition I would still recommend that you buy the third edition. It is good to be reminded of bubbles from time to time. Below I am appending my review of the second edition.

REVIEW OF SECOND EDITION
Economists have until rather recently refused to pay attention to emotions (driven by culture and psychology). Well by now, some cutting edge researchers have studied these phenomena for 20 years, but it is only during the last 10 years that these ideas have had any mainstream impact. And writing in 2011, I would say that these ideas do not yet have any major, systematic impact on economic and finance thinking.

This book is a book written by an economist who have realised the importance of these ideas for some time. The core question in the book is to try to understand the non-economic factors in society that create asset price bubbles. The book is well written and its author is aware of all the research done in the area. Off course the original edition was published in 2000 so the research has moved on and I would not consider the book cutting edge any more.

Still, I am not aware of any better book on the subject and I would consider this book a must read. Be sure to get hold of the second edition from 2005. Given the success of the predictions in the book I would not be surprised if we see a third edition. There are still bubbles waiting to burst (government bonds in the US, property prices in London, etc.). Still, a third edition is probably not shortly forthcoming given the fact that we are not really in a bubble economy in the US. So get hold of the second edition and read it.

The author has a more recent book called Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism (New in Paper). In my mind that book is vastly inferior to the older book. The more recent book deals with irrationality in economic behaviour in general, not just in financial markets.

Funny in a way that every time Professor Robert Shiller publishes a new edition of Irrational Exuberance, there would be a major crisis in the financial market. He tended to be a few years earlier in warning about the bubbles, and it took a few years to publish this book (as suggested by Professor Shiller in his preface), then this book becomes a perfect predictor of market crisis. Don't quote me on that; I am just joking.

It is quite enjoyable to read about Shiller's work after reading so much Fama's work. They got Nobel Prize at the same year but they are in two distinct camps. His empirical research on bubbles was great, changing so many of my views before. Like housing, I didn't know there were very few systemic housing bubbles before, until I read this book.

Professor Shiller also pointed out that much of major market collapse was not about news on that day, but some signals that the market took a few days, or even weeks, months before the final crash. Signal circulated within the system, and probably it is worth learning more about chaos theory, as suggested by Shiller?

Anyway, a must-read work in modern finance, even if you are with Fama.

Economists have until rather recently refused to pay attention to emotions (driven by culture and psychology). Well by now, some cutting edge researchers have studied these phenomena for 20 years, but it is only during the last 10 years that these ideas have had any mainstream impact. And writing in 2011, I would say that these ideas do not yet have any major, systematic impact on economic and finance thinking.

This book is a book written by an economist who have realised the importance of these ideas for some time. The core question in the book is to try to understand the non-economic factors in society that create asset price bubbles. The book is well written and its author is aware of all the research done in the area. Off course the original edition was published in 2000 so the research has moved on and I would not consider the book cutting edge any more.

Still, I am not aware of any better book on the subject and I would consider this book a must read. Be sure to get hold of the second edition from 2005. Given the success of the predictions in the book I would not be surprised if we see a third edition. There are still bubbles waiting to burst (government bonds in the US, property prices in London, etc.). Still, a third edition is probably not shortly forthcoming given the fact that we are not really in a bubble economy in the US. So get hold of the second edition and read it.

The author has a more recent book called Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism (New in Paper). In my mind that book is vastly inferior to the older book. The more recent book deals with irrationality in economic behaviour in general, not just in financial markets.

During the 1990's the cheeky Swedish TV-character Gert Fylking, dressed in an awful pink tracksuit had the habit of shouting "Finally!" when the Nobel Prize committee announced another obscure literature prize winner to the waiting possy of pretentious culture journalists. This year I fully agree with Gert when it comes to the Nobel Prize in Economics, finally Bob Shiller gets the award. On the financial market Shiller is mostly know for the valuation multiple Shiller-PE and the Case-Shiller real estate index. However he's a towering figure when it comes to financial theory that's brought forward the still underappreciated notion that longer term average future returns vary with the starting valuation.

Shiller was a pioneer in showing that asset prices weren't random. As early as in the 70's he could show that asset prices were more volatile in the short term than was motivated by their fundamentals. This implies that prices are mean reverting and hence that above-average returns in average are followed by below-average results. In direct conflict with the academically dominating Modern Portfolio Theory this pointed to predictability in asset returns. In practical terms it was possible to formulate profitable strategies based on valuation multiples as long as the denominator is relatively stable (dividends, trend earnings etc.). Pressing further, Shiller explained this predictability with psychological factors such as herding and fads and by this became one of the early key proponents of Behavioural Finance.

Irrational Exuberance that was published early 2000 at the peak of the TMT-bubble was one of two remarkable books that by way of pointing to the markets valuation warned of the bubble and predicted that the stock market world show negative or very low returns the coming decade. The other book was Andrew Smithers' and Stephen Wright's Valuing Wall Street. The name of Shiller's book was immortalised by Alan Greenspan who borrowed the expression from one of Shiller's presentations and used it in one of his speeches. Greenspan didn't have the same impeccable timing as Shiller though.

The opening chapter presents the Shiller-PE that the author readily admits to have borrowed from Ben Graham and David Dodd. The multiple is constructed by dividing current price with the average of the prior ten years of real EPS. He shows a clear correlation between the level of the PE-ratio and the coming ten years stock market return. At the time of publication the ratio was at the highest level in the last 120 years which lead Shiller - at the height of the optimism - to conclude that: "Long term investors would be well advised to stay out of the market". Today we know how spot on he was.

The bulk of the book discusses structural, cultural and psychological factors behind the on-going TMT-bubble. For an academic this part of the book (and the rest also for that matter) is surprisingly easily written. It's fluent and seamless. The topics will not surprise anyone who was in the market at that time: it's about the change of zeitgeist when it comes to admiration of monetary success and the belief in a "new economy"; self-enforcing loops between asset prices and investor confidence, an explosion in media coverage of the stock market giving coverage to an ever growing amount of stories, the changing of financial multiples to justify prices, increasing amounts of fraud, the proliferation of day traders, psychological herding etc. etc. The book ends with a more philosophical discussion regarding the extent to which it is morally just to try to protect people in a free society from the psychological mistakes they make by their free will.

The releases of Irrational Exuberance and Valuing Wall Street have been called the "most well timed 1 - 2 punch in financial history". The amazing thing is that in early 2008 Shiller repeated the feat by publishing The Subprime Solution discussing a bubble in the US real estate market. I hope his Nobel speech reveals the topic of his forthcoming book. Finally!

This is a review by investingbythebooks.com

This book serves as an awakening call from "the present...whiff of extravagant expectation, if not irrational exuberance, in the air. People are optimistic about the stock market. There is a lack of sobriety about its downside and the consequences that would ensue as a result." The author advances that "we need to know if the price level of the stock market today, tomorrow, or any other day is a sensible reflection of economic reality, just as we need to know as individuals what we have in our bank accounts." That being said, the purpose of the book is to advance "a better understanding of the forces that shape the long-run outlook for the market."

This book covers a myriad of factors ranging from technology, to cultural to psychological that aid the formation and reinforcement of speculative bubbles. It ends with a section on implication of these findings on the various members of society whether individuals, institutions or government.

Below are key excerpts that I found particularly insightful:

1- "Many of the foregoing factors (that are candidates for causing a market boom) have a self-fulfilling aspect to them, and they are thus difficult, if not impossible, to capture in predictive scientific explanations."

2- "There are many ultimate causes for this exuberance...and the effect of these causes can be amplified by a feedback loop, a speculative bubble, as we have seen in his chapter. As prices continue to rise, the level of exuberance is enhanced by the price rise itself...The changes in thought patterns infect the entire culture and they operate not only directly from past price increases but also from auxiliary cultural changes that the past price increases helped generate."

3- "The role of the news media in the stock market is not, as commonly believed, simply as a convenient tool for investors who are reacting directly to the economically significant news itself...The news media are fundamental propagators of speculative price movements through their efforts to make news interesting to their audience. "

4- "Ends of new eras seem to be periods when the national focus of debate can no longer be upbeat. At such time, a public speaker may still think that it would be good business to extol a vision of a brilliant future for our nation's economy, but it is simply not credible to do so. One could, at such times, present a case that the economy must recover, as it always has, and that the stock market is underpriced and should go up, but public speakers who make such a case cannot achieve the command of public attention they do after a major stock run-up and economic boom. There are times when an audience is receptive to optimistic statements and times when it is not."

5- "We have explored the justification people have given, at various points in history, for changing market valuations, and we have seen evidence of the transitory nature of these cultural factors. Ultimately, however, the conclusions we draw from such evidence depend on our view of human nature and the extent of human abilities to produce consistent and independent judgements."

6- "Two kinds of psychological anchors will be considered here: quantitative anchors, which themselves give indications for the appropriate levels of the market that some people use as indications of whether the market is over-or underpriced and whether it is a good time to buy, and moral anchors, which operate by determining the strengths of the reason that compels people to buy stocks, a reason that they must weigh against their other uses for the wealth which they already have (or could have) invested in the market."

7- "The effects of new stories on the stock market sometimes have more to do with discovery of how we feel about the news than with any logical reaction to the news. We can make decisions then that would have been impossible before the news was known. It is partly for this reason that the breaking off of a psychological anchor can be so unpredictable: people discover things about themselves, about their own emotions and inclinations, only after price change occur. Psychological anchors for the market hook themselves on the strangest things along the muddy bottom of our consciousness."

8- "Rationale response to public information is not the only reason that people think similarly, nor is the use of that public information always appropriate or well reasoned."

9- "Policies that interfere with markets by shutting them down or limiting them, although under some very specific circumstances apparently useful, probably should not be high on our list of solutions to the problems caused by speculative bubbles. Speculative markets perform critical resource-allocation functions, and any interference with markets to tame bubbles interferes with these functions...Most of the thrust of our national policies to deal with speculative bubbles should take the form of facilitating more free trade, as well as greater opportunities for people to take positions in more freer markets. A good outcome can be achieved by designing better forms of social insurance and creating better financial institutions to allow the real risks to be managed more effectively. The most important thing to keep in mind as we are experiencing a speculative bubble in the stock market today is that we should not let it distract us from such important tasks."

a good read, esp. for anyone who may believe that market movements are based purely on 'fundamentals'...other reviewers have covered a lot of ground - i'll just add a couple of notes i didn't notice in other reviews...
first, i have to object to the "irrational" part of the title (yes, the phrase is attributed to Greenspan, but the author chooses to use it nonetheless..)...that market response relies to a considerable extent on investor 'exuberance', yes, and certainly there can be over-exuberance leading to bubbles, at times...but I don't see that investors are acting irrationally, in general...rather it seems to me that investors react quite rationally to the usually noted market forces, such as company earnings and the pronouncements of key individuals (Fed chair, etc.)...that the markets may be driven too high or too low, based on some hypothetical examination of 'fundamentals', seems to me not so much due to investor irrationality as it is to generalized uncertainty - it's hard (probably impossible..) to know and understand all the relevant information; hard to call/know a market top or bottom, and there is no simple formula that sets a stock price...
my second issue relates to the following quote: “overinvestment by corporations, encouraged by the booming stock market, led to a collapse of investment spending in the early years of the twenty-first century, and to a worldwide recession” (preface to the 2nd edition) – assuming the author is correct, this seems like a pretty major factor for understanding the tech crash (at least), and needs significant elaboration that the author fails to provide...

The introduction is about the stock market and the real estate market. In these two chapters he shows the abnormalities of speculation. It is a historical view on price earning ratios and rural price developments.
The first part begins with the technological developments that increase the trends in investments. These include a trend in ownership, more reports in business on the media and online accounts for trading. The psychological aspects show more implication on the bubbles. A feedback model shows the effects on a self-fulfilling investment trend. The facts include the psychological aspects on the behaviour of the people. He shows this in survey reports.
In the second part he follows the idea that the media had no significant influence on the stock market returns. He summarises the great crashes in the last century and gives you the reasons for it.
The third part goes back to the psychological factors. Most people referees to an anchor in their investment decisions. It can be the price of the stock in the last year or a story which is told by the company. Most of the people can not find the right price of a stock. So they are overestimating the price and have a false probability distribution. These factors lead to a bubble because the people follow information cascades and there is a trend for herd behaviour.
In the fourth part he wants to rationalise the market movements. The efficient market hypothesis is the best model to explain the current price of a stock. He doubts this and compares it with the market model of stock valuation. It is the discount model of dividends that scribes the stock price. To test the efficient market hypothesis he goes the wrong way. You can test the efficient market hypothesis with a dividend model. The hypothesis says that the market is at any time efficient, all given information about the past are correctly priced and you can't beat the market in the long run. No mutual funds manager had beaten the market yet, if you compare the same stocks and an appropriate index. Long Term Capital Management had the theoretical knowledge and the technical abilities to test this but they went bankrupt. The long term is often to long to finance any loses. If you invest in an exchange traded fund you had the best investment. The ETFs had performed better than any mutual fund. Therefore the efficient market hypothesis holds. The best explanation of a bubble is the experiment by Vernon Smith. He showed the results in his article in the Econometrica of 1988. There are other factors that influence the market. In a constant dividend time horizon there is a possible change of a bubble.
The last chapter deals with Risk in a free Society and a plan for action to cope with the volatility in the future. It is about more moral standards in the lending practise and a plan for more saving from the income. You must diversify your portfolio above all assets classes.
It is a well written book. It gives you a new view on the markets. An economic view with a different approach.

Shiller has great crediblity based on past predictions, not to mention a Nobel Prize. He is undoubtedly correct in his assessment that investor psychology can lead to substantial mispricing of assets just as Keynes noted the importance of psychology to investment and GDP growth. "Irrational Exuberance" is well worth reading, but at the same time it is a little disappointing, as discussed later.

I was surprised by Shiller's Figure 4.1, which shows that investor confidence that stocks prices were NOT overvalued hit a low point just BEFORE the dot.com bust. This seems to suggest there was not irrational exuberance, which there clearly was. The chapter "New Era Economic Thinking" puts the internet, as a possible game changer, into nice historical perspective. Later, Shiller has a good discussion of the history of rates of return on stocks vs. bonds, which should dent confidence that stocks will always work. True, the last 30 year period in which bonds outperformed stocks began in 1831, but there have only been five non-overlapping 30 year periods since then. In the 20th century, following peaks in the price-earnings ratios, stocks under performed short term bonds in only one of the three 20 year periods, but in the other two, real returns were low (actually, from 1966-1986, the real annual return, i.e. corrected for inflation, was 1.9%, and Shiller elsewhere talks approvingly of an inflation adjusted treasury yielding 2.0% real rate of return).

Shiller uses a very simple approach for dealing with inflation without any discussion of limitations and complexities; e.g. profits tend to be hurt by the tax consequences of inflation, and the stickiness of prices. In his Figure 1.3, designed to show that interest rates are not relevant to price to earnings ratios a different scale for interest rates would be helpful, since under the popular "Fed model" for price to earnings ratios, a change from 1.5% to 3.0% would be hugely significant. There are a number of instances of questionable assertions; e.g.,"A decline in crime rates has encouraged materialistic values by making people feel more secure,.... "(p.36). The reader gets the impression that the book was written relatively quickly.

One would hope that now, years after speculative bubbles led to the 2008 'Great Recession,' things would be different - people have learned their lessons and no longer follow the crowd into expanding markets. Author Shiller, however, tells us that evidence of bubbles has worsened, despite a disappointing world recover from the Great Recession, a paralyzed and polarized political climate, and worsening international situation (Middle East, Ukraine). In other words - continuing bubbles in the stock market and housing, just as we 've had for over a century in America, now expanding to the rest of the world.

His history of bubbles in the U.S. stock and real-estate markets was quite enlightening. He constructed price-earnings ratios, monthly, with inflation-adjusted S&P Composite Stock Price Index as the numerator, with the denominator consisting of a ten-year moving average of real S&P Composite earnings for the last 100+ years. The ratio hit 25.2 (6/1901), 32.6 (9/1928(, 24.1 (1/1966), 47.2 (3/2000), and is now at about 25.

home prices took off sharply between 1998 and 2006. Real home prices for the U.S. overall increased 85% between 1997 and 2007, vs. tripling of stock market prices between 1985 and 2000. There was only one other period of similarly large price increases in U.S. history - the period beginning with 1942 and extending past the end of WWII. These increases were not created by a runaway speculative boom - government restrictions had severely limited the supply of new houses during WWII, then came the G.E. Bill (1944) introducing subsidization of home prices. The late 1990s run-up cannot be explained by changes in building costs, interest rates or population growth rates, and was much faster than the growth in incomes. The cost of buying a house relative to renting doubled in the U.S. from 1997 to 2006, then fell about all the way back down from 2006 to 2013.

Booms in the stock market bear little relation to booms in the housing market - with the possible exception of the most recent housing boom, lagging stock peaks by about two years. From 1890 to 1940 home prices were slightly declining, though local booms occurred via road and railroad building. Prices in Boston and L.A. went through two dramatic upswings after the WWII upswing - the first occurring in the mid-late-1980s, and the second 2000-06, while Phoenix and Miami missed the first boom, and fell back after the second to where they're hardly changed between 1983 and 2011. Overall, real home prices in the U.S. were almost 2X 1890 levels in 2006, but that increase took place in two brief periods - from 1942-just after WWII, and 1998, after the 1990s stock boom.

Home prices are thought to have advanced more than they have because of the infrequency with which people buy homes, and the fact that stock splits have kept those prices much more constant. Home quality has also increased substantially over the long run. Long-term incentives to buy rather than rent include tax advantages, and increased rents due to the moral hazard associated with renters lacking incentives to keep up their residences. Not until relatively recent times has there ben much talk of housing price increases over time - instead, much more concern over rent increases.

Precipitating Factors the Propelled the Late Stages of the Millennium Boom, 1982 - 2000: 1)Arrival of the Internet at a Time of solid Earnings Growth. U.S. corporate earnings growth for 1994 was up 36% in real terms, followed by another 8% in 1995 and 10% in 1996. The real drivers of this improvement were continuation of the slow recovery from the 1990-91 recession, a weak dollar and strong foreign demand for U.S. capital and technology exports, and cost-cutting initiatives. Nonetheless, many credited the Internet with boosting earnings, and expected this to continue. 2)Weakening of Russia, Accompanied by China's adoption of market forces. 3)The Rise of Materialistic Values - fewer stay-at-home moms, declining crime rates, increased media reporting of business issues. 4)The Capital Gains Tax Cut of 1995 - from 28% to 205. Many hoped it would be reduced even more. 5)Increasingly Optimistic Forecasts by Analysts - only 1% of recommendations were 'sell' in late 1999, vs. 9.1% ten years earlier. Fear of being shut out of future interviews, employers' conflict of interest (they did not want to jeopardize underwriting), and 'grade inflation' contributed. 6)Expansion of Defined Contribution Pension Plans - reduced employer contributions. 7)Expanding Trade Volumes - discount brokers, day-trading, and expanded gambling (risk-taking) contributed. 8)Supportive Monetary Policy - the 'Greenspan Put.' 9)Globalization. Shiller did not list this item; however, globalization allowed companies to buy goods at lower costs, put a leash on unionized work forces, dramatically cut capital expenditures, and boost profits.

'New Era' Thinking --> 'this time it's different thinking: Rapid technological progress (eg. cars, appliances, road-building, etc.), computerization, the Internet, mergers (scale), productivity growth (helped by some erroneous BOL statistics), seeing Asia as a vast new market, belief that 'we'd learned how to tame the business cycle,' and deregulation to free Adam Smith's 'invisible hand' (not mentioned by Shiller).

Each story is different, but the underlying mindset is the same - each contagion promotes a mindset that justifies the price increases and appears to make participating in them rational. Further, in housing markets, there is no possibility of short sales to raise flags in that market.

Suggests monetary policy gently lean against bubbles, and opinion leaders offer stabilizing opinions. However, both actions risk undermining our currently tenuous economic situation.

This book gives a broader insight into the operation of economies that goes beyond the financial area with which it deals. Together with the work of Taleb, the key here is the notion of feedback effects and the omnipresent uncertainty which economic actors try to minimise.

To my mind this work is rather like a keyhole where as the reader progresses through it's pages, the other side begins to emerge as a panoramic spectacular technicolour landscape.

It is a fascinating book which can be mined on more than one occasion

Shiller sees current market price-earnings ratios (mid-20s) as still far higher than historical averages, and President Bush's "Ownership Society" a plus for economic growth but also encouraging speculation.

Further evidence that the market is overpriced is that the DJIA was about 3,600 in early '94, and then passed 10,000 during March, 1999 - tripling in 5 years, while GDP rose less than 40% and profits less than 60%. As for real estate, Shiller reports that in the eight most volatile states median home prices rose from '85-'02 from 4.9Xper capita income to 7.7X.

Why these large increases? Shiller offers a number of explanations:

1)Most investors are unaware of the troubling lack of credibility of most stock market research.

2)Mortgage lenders began including a wife's income during the 1970s in qualifying for a loan.

3)Capital gains tax cuts in '97 and '03. Also Proposition 13's passing in California.

4)Greenspan creating the impression that major losses would be prevented - eg. the Federal Reserve's stepping in after the '87 crash, '98 Russian debt crisis and Long Term Capital Management's failure, and the Y2K crisis.

5)Analysts' consistently optimistic forecasts (eg. only 1% said "Sell"), combined with the onset of regular business reporting on cable.

6)The growth of IRAs and mutual fund advertising.

7)Greenspan's "justification" for new stock levels through concluding that we were in a "new era" - tremendous business improvement via computers, without inflation or business cycle downturns. (A turnaround for Greenspan who in '96 originated the term (and concern over" stock market "irrational exhuberance.")

Shiller's recommendations include a monetary policy that gently leans against bubbles (he also points out that the 1930's Great Depression was substantially due to monetary authorities' trying to stabilize speculative markets through interest rate policies), opinion leaders offering stabilizing opoinions, imroving Social Security's design - reducing the felt pressure to invest for greater return (how would this occur without putting further pressure on stock market prices is not made clear), placing company funded/supported retirement plans on a sounder footing (same problem as prior recommendation), and an effective plan to increase savings (again, I'm unsure how this would

About Robert J. Schiller's book, Irrational Exuberance (2000; 2nd ed., 2005), it's hard to say enough good things. First Schiller, who is Stanley B. Resor Professor of Economics at Yale University, had uncanny timing. His warning on the excesses of the technology bubble stock market came out at its very peak, in mid-March of 2000. He wrote in an afterward to the paperback edition (2001) that as he made publicity visits to bookstores in April of 2000, a large carnage had already occurred in the market, particularly for tech stocks and e-business names. Second, he writes in a transparent style. Third, he and his team, instead of tossing out opinions about what they think investors do, carry out frequent sample surveys of both individual and institutional investors. Fourth, he undergirds his hypothesis with numerous insights from economics, psychology, game theory and history. Finally, he gives many cross-references to booms and busts around the globe.

The second edition points to over-valuations in the U.S. real estate market that Schiller believes were comparable to the excesses of the dot-com era in stocks. This prediction may prove to be accurate as well, but the unraveling so far has not proceeded in so dramatic a fashion as did the technology crash.

From what valuation method does Schiller proceed his analysis of stocks? Fundamentally, he bases it on price-earnings ratios. (Price-earnings ratios have been shown to be a crucial characteristic in predicting long term stock portfolio performance; see James P. O'Shaughnessy, What Works on Wall Street [1998, rev.]). More precisely, he uses as his numerator the real (inflation-adjusted) S&P (Standard & Poor's) Composite Stock Price Index. For the denominator, he uses the moving average of the past ten years of real S&P Composite Earnings. Advantages of these data series: the source is considered reliable; they go back to 1841 continuously; they are inflation-adjusted.

Using the price-earnings data and ratio as defined above, a first great cyclical high can be seen in June 1901: a P/E ratio of 24.5 times. Subsequently, P/E declined, and stocks performed in a desultory fashion, until June of 1920. The second great peak, occurring at the end of the Roaring Twenties, was 32.6 times--reached during September of 1929. The Great Crash followed. A third peak occurred during the so-called "go-go" era of the 1960s: 24.1 times in January of 1966. This too came a cropper, followed by years of stock market underperformance--bottoming out in terms of P/E ratio in the early 1980s. The US stock market P/E ratio at the height of the technology boom in 2000 reached an unprecedented 44.3 by January of 2000. Then, boom-boom, out went the lights!

Schiller explores from many perspectives just how markets sometimes reach such giddy highs. One "amplification mechanism" is likened to a naturally occurring Ponzi process. Charles Ponzi attracted 30,000 investors and $15,000,000 within seven months during 1920. Ponzi promoted his scheme by cashing out some early investors, which excited many followers. Ponzi schemes always involve an attempt to pyramid investor inputs while wasting or defrauding much of the principal outside of the touted investment theme. Schiller points out that rapidly rising stock markets can bring in an unintended Ponzi dimension, as late-comers seek to replicate earlier investors' apparent success.

Such feedback loops lead to circles of investor behavior, which can promote the expansion of a bubble, but also can lead to its rapid deflation. Schiller also shows how news media attention to feedback loops can intensify their force and expand the volume of participation by investors. Often, behind investment fads, there are popular ideas about "new eras" that supposedly render irrelevant any historical comparisons. Feedback loops are facilitated by the demonstrated over-confidence of many individuals in their judgments as well as by evolved patterns of mass behavior.

Generally, markets threaten to become untethered whenever investors' principal focus is on price performance rather than fundamental value criteria. In such an atmosphere, it can be imagined that trees truly can grow to the sky. Or at least that there will be a "greater fool" who will take you out of your investment in a timely fashion.

Schiller does not purport to offer a rule of thumb for market trading practice. Indeed, any scheme that could be used continuously and in static form to operate a successful trading system (a putative "money machine") would surely be arbitraged away by perceptive traders. Instead, he lays out a more intuitive case for how to avoid investing in major market excesses when they occasionally occur. His proposed solutions included a salutary emphasis on hedging activities. Some of the hedges he lays out are novel but may not be practical to implement, owing to the problem of illiquidity (lack of ability to trade).

(The author of this review, Andrew Szabo, is founder of MindBodyForce.com)

"Irrational Exuberance" is an expression that was actually coined by Robert J Shiller, and was used in his briefing of Alan Greenspan in 1996 before the Chairman of the Federal Reserve immortalized it in a public setting. The expression was used as a warning against a possible speculative bubble in stock market prices. As we know now, the market continued to climb until 2000 when it collapsed. The first edition was published just before the dramatic fall of the market, making Shiller somewhat of a guru of speculative bubbles.

Shiller points out that the Dow Jones had gone from 3,600 in 1994 to 11,700 in 2,000; the price-earnings ratio had reached an incredible 44.3. When the stock market crashed in 1929 the p-e ratio was at 32.6. By 1932 the market had lost 80% of its value. As we have seen, the bubble of 1929 pales in comparison to the bubble of 2000.

Traditional financial theory assumes that people act rationally when they make investment decisions. Investors ideally examine financial statements, calculate returns, evaluate economic factors, and then determine whether to buy or sell.

Shiller is an economist who specializes in behavioural finance and thus tends to emphasize cultural and psychological factors that cause people to invest in assets that have risen over and above levels justified by rational theory.

He identifies twelve factors that have led to the bubble in 2000:

1) The fall of the Berlin Wall and China's shift to a market economy, which led to the triumph of capitalism.

2) People are more materialistic than they were in the past. According to polls, everyone wants to get rich.

3) New technologies led people to believe that they were at the dawn of a new age prosperity.

4) Monetary policies encouraged a bubble rather than choking it off.

5) It was believed that the impact of the baby boomers on the market would be profound and lasting.

6) There was more media coverage of people getting rich during the boom, thus creating a "positive feedback loop."

7) The analysts were giving positive reviews of stocks, not because of fundamentals, but because the stocks were being underwritten by their employers.

8) Pension funds were speculating in the market trying to get better returns than the traditional fixed rate.

9) The enormous growth of mutual funds fueled the boom.

10) The persistence of low inflation was a factor.

11) The introduction of online trading expanded the opportunities for speculation.

12) The general mentality of casino society has set in with the huge increase of gambling.

With the publication of the second edition of his book, Shiller argues that many of these factors are at work in the real estate market boom. The prices of US homes have increased 52% from 1997 to 2004. Historically this is unprecedented. Today people are speculating in the real estate market like they did in stocks in the 1990's, and much like the stock market, the phenomenon is global. It is happening in London, Vancouver, Moscow, Shanghai, and elsewhere. All the indicators of a speculative bubble are present.

The problem I have with this book is that Shiller tries to explain increase in market value only in terms of psychology, and fails to take into account the real value that has been added on a scale unprecedented in history. Globalization, as Thomas Friedman describes it in "The World is Flat," has created new and lasting efficiencies in the global economy that resulted from the internet and other technologies. Even though technology stocks crashed in 2000, the internet and all of its benefits did not disappear, it in fact supercharged the global economy. The Dow Jones is almost back to where it was five years ago.

Shiller, however, is cautious about predicting a similar collapse of the housing market. He does warn against the false belief that home prices will inexorably increase because of growing populations and widening prosperity. Instead he advises to diversify into many classes of assets to dilute risk.

This book does not advise you to sell your home or any other property you may own, nor does it give any specific investment advice; it does, however, give an excellent overview of all the indicators of a speculative bubble.

Stock markets are complex and mysterious creatures. Predicting their behavior is a fantasy that has persisted in investors' minds for ages, and various tricks have been conjured to anticipate (and profit) from stock movements. What all these techniques have in common in an expectation that markets can indeed be predicted-and that they all, invariably, fail.
Robert Shiller, of Yale University, contributes to this debate by canvassing the salient features that characterize the stock market. First, he argues that markets tend to be irrational: prices skyrocket based on frenzy, not fact. Price-earning ratios, for example, tend to move much higher than earnings, implying that expectations are not based on higher expected earnings. The same irrationality, Mr. Shiller continues, can be observed in the relation of stock prices to dividends: stock prices are more volatile than dividends, meaning that prices cannot be fully reflective of expected dividends, as the efficient market theory would predict.
So what determines stock prices then? This is the book's most creative part, at least for those familiar with economics but not psychology. Two factors, the media and "new era" thinking, tend to create an undue optimism about markets, causing prices to exceed rational limits. These two trends, however, are amplified by psychological phenomena: an overwhelming trust in the opinion of authorities, overconfidence in one's investment strategy, a linear reasoning that cannot be defended against uncertainties or complications, and so on.
Any reader should be impressed by the complexity and accessibility of Mr. Shiller's analysis. If his book is taken as a prognosis of the 1990's bubble bursting, then "Irrational Exuberance" is a timely warning that proved correct. But what makes this book a classic is its magnificent combination of economics, econometrics, sociology and psychology in analyzing the stock market. This much needed interdisciplinary work makes this book a must read for investors and policymakers alike.

In a welcome second edition of the book, Shiller sets up his main theses using the real estate "bubble" (or if you prefer, "boom") example. The first part of the book focuses on a historical analysis of the "bubble" scenarios and uses the recent real estate phenomenon to explain the context of his arguments. He systematically argues against all the reasons cited for the real estate boom (population, construction costs, etc.) In the second part, he focuses on causes for these speculative behaviors of investors and their changing perceptions on risk. His classification of factors into precipitating and amplifying groups is an interesting approach. He then proceeds to explain cultural, political and psychological factors to reason why he thinks investors behave in a "speculative" mode. His attack on the cable TV news media and their "noisy" coverage of business news is an amusing and thought-provoking read.

Any serious investor for the long term (and short term) will find the insights on market behavior very useful in analysing his/her own behavior. The efficient market theory, "greater fool" theory, etc. will also need a more critical look after reading Shiller's comments.

This thought provoking book is an excellent read along with Jeremy Siegel's (one of the authors friends/advisors) book which takes a much more positive perspective on market trends and more importantly, market behavior.

While the strength of the arguments will keep the reader interested, the book is no easy week-end read. It needs to be read in a slow pace to absorb the gravity of the arguments. But that shouldnt deter a serious investor. A must have.

If you are primarily invested in stocks, this book will provide an excellent counterpoint to the constant hype and chatter that emanates from CNBC and Yahoo Finance, themselves targets of criticism in this book.
Belief that the markets will rise in the "long-term" is just that: a belief. As with any faith, there is history. Shiller examines the source of this faith in the same way an anthropologist might examine an ancient religion. Shiller examines human nature and the mechanisms of the media and the markets that amplify these tendencies. He supports these arguments by citing numerous studies and graphs. To further strengthen his arguments, he considers the views of perma-bulls and tackles their arguments head-on. Finally, he makes a surprising recommendation on how to invest for the next twenty years, a recommendation that has been echoed by none other than Warren Buffett.
As with any controversial book, Shiller is not without his critics who attempt to tear down his arguments. Although his arguments are not iron-clad, neither are his critics' arguments. With the decline of the NASDAQ from above 5000 to below 2000, it is time to revisit this book.

I've always enjoyed articles by Yale economist Robert Shiller, so I had high hopes for "Irrational Exuberance", not least because it has been talked up in every financial journal, web site, or newsletter that I read. I was disappointed. "Irrational Exuberance", borrowing a phrase from then-Fed Chairman Alan Greenspan, attempts to explain the psychological bases of speculative bubbles. The first edition addressed the millennium tech stock bubble and was published just months before it burst in 2000. This second edition has added a chapter on the housing bubble of the mid-2000s and incorporates commentary on residential real estate bubbles in some other chapters as well. It was published in 2005, also shortly before that bubble burst.

Shiller begins with brief chapters on historical stock market and real estate bubbles, to give the reader some perspective and demonstrate why these were, indeed, bubbles. He then names 12 factors that he believes precipitated the stock boom of the 1990s that culminated in a bubble: global capitalist explosion and the "ownership society", cultural and political change favoring business success, new information technology, supportive monetary policy and the Greenspan Put, Baby Boom and Baby Bust, expansion in reporting of business news, analysts' optimistic forecasts, expansion of defined contribution pension plans, growth of mutual funds, decline of inflation, expansion of the volume of trade, rise of gambling opportunities.

"Irrational Exuberance" analyzes the psychological factors behind bubbles, those that are not rational or due to economic fundamentals. Shiller discusses feedback theories of markets, the role of the media, examines the potential role of big news stories (which he concludes are not an important factor), the concept of "new era thinking" that preceded the 4 major stock market peaks of the 20th century, and speculates on why people are deceived by bubbles, which he terms "naturally occurring Ponzi processes". He references a lot of psychological studies that demonstrate people's overconfidence in their own judgments -and others that demonstrate that people will believe the majority view or expert view even if it strikes them as wrong.

There is not a lot of economics in "Irrational Exuberance". It's about psychology. Shiller has distributed a lot of questionnaires and analyzed a lot of data over the past few decades in attempts to understand the psychology of markets. But he often cites surveys of the public at large, most of whom do not directly participate in the stock market, when talking about market behavior. And he cites a lot of psychological studies that draw dubious conclusions. He quotes a Barron's survey from April 1999 in which 72% of respondents believed that stock market was overpriced. This would indicate that the problem is not that people are fooled by bubbles, but that some flaw in management discourages them from acting on their understanding. Shiller doesn't have much to say beyond the obvious, which he stretches to 230 pages by doing things like discussing epidemic models after he has just stated that they can't be applied to the spread of ideas.

Schiller's case rests on a rich mix of quantitative and qualitative research and analysis. (By qualitative, I include his surveys of fund managers with small sample sizes). He challenges a great many points of conventional wisdom, showing them to be neither conventional nor wise.
One thing he fails to do, however, is systematically refute the hypothesis that high valuations (especially for tech stocks) are justified. Real option pricing, for instance, does demand an approach completely different to that of traditional discounted cash flows: if an investor wishes to take on the risk of an unproven business model, with its attendant uncertainty but large potential upside, that is not necessarily irrational.
Schiller's answer is that the P/E ratios are so far off the historical norms that it's not worth discussing further. And the option pricing view can't hold for the whole market.
The challenges to efficient market theory, and to Jeremy Siegel's (of the Wharton School at U Penn) views in "Stocks for the long run" are similarly one step short of complete.
That said, this book serves the invaluable function of challenging the complacency that pervades popular opinion and the media. My own favourite manifestation of this is the Economist's observation that when stocks rise, newspapers describe them as "strong"; when they fall, they are "volatile". What's in a name? Market sentiment, which drives prices to unsustainable levels.
This book was written because the author cares. Both as an academic and as an observer of public policy, he rightly fears the effects of a collapse in the markets. He deserves to be read.

Robert Shiller starts his book by stressing the troubling lack of credibility of research and analysis being done on the stock market, to say nothing of the clarity and accuracy with which it is communicated to the public. "To be fair to the Wall Street professionals whose views appear in the media, it is difficult for them to correct the basic misconceptions about the market because they are limited by the blurbs and sound bites afforded them. One would need to write books to straighten these things out, writes the author. This is such a book."

Sometimes a picture or a graph is worth a thousand words. By plotting the S&P stock price index expressed in real terms or the evolution of price relative to earnings, Shiller vividly depicts the unsustainable nature of the high-tech boom that ended at about the time the first edition of the book was published. He also identifies three other episodes of grossly inflated prices: the Twentieth Century Peak of 1901, the market frenzy that ended with the Black Monday crash of October 28, 1929, and the go-go years of the 1960s. He characterizes these market episodes as speculative bubbles--unsustainable increases in price brought on by investors' buying behavior rather than by genuine, fundamental information about value.

There is always a vast supply of theories in bubble times to justify the market heights and to nurture bullish views about the future. Shiller lists several factors that plausibly caused the market to climb in the last recent episode of "irrational exuberance": the arrival of the internet, the decline of foreign economic rivals, the surge in materialistic values, the growth of mutual funds, the expansion of defined contribution pension plans, the decline of inflation, the declining cost of making a trade, and others. Each factor played a role and they certainly reinforced each other in a unique combination, but, as the author notes, most of them are one-off events and they do not by themselves justify a radical departure from the past or the dawn of a new era of permanently high prices. Indeed, Shiller shows that the belief in a radical change in the rules of the game, what he calls `new era economic thinking', accompanied all previous market peaks in US history.

Whet makes people receptive to these optimistic statements is not, as the title of the book would suggest, a kind of irrational exuberance or collective madness, but is rather to be found in patterns of human behavior identified by psychological research. People tend to make judgments in uncertain situations by looking for familiar patterns and assuming that future patterns will resemble past ones. They need psychological anchors to determine whether stocks are priced right or when to enter and exit the market. They hold beliefs which they like to see confirmed, and the media industry can slant stories toward these beliefs. Indeed, the media and the investment community have an interest in encouraging conventional wisdom about the market and exploiting the get-rich fantasy. As the author notes:

"People writing for or quoted in the media regularly pose the question, after a big one-day decrease in the market, of whether this time the market has `found its bottom' or, after an increase, whether the market has `begun a long-term rally'. The symmetrically opposite questions seem never to be asked. One never sees media accounts after an increase inquiring whether the market has `found its top' or, after a decrease, whether the market has `begun a long-term decline.'"

The conclusion is cautiously optimistic: if reasonable attitudes toward risk and return are promoted by opinion leaders and transmitted through word-of-mouth or by virtue of example, the general public will `unlearn' some basic misconceptions about the stock market and will take proper steps to protect their existing wealth from excessive risk. No doubt this book will have contributed to this result.

Shortly after a briefing by author Robert Shiller, Alan Greenspan warned the country about the "irrational exuberance" pushing stock prices excessively high. The year was 1996 and, in hindsight, it's clear that the bull was just beginning to run. Anyone who heeded that warning would have passed up some of history's most impressive gains. Yet, if history is any guide, stock prices could be in for a 10 or 20 year decline, falling back below the bull market's gains. But Shiller isn't teaching market timing; he's debunking some cherished investing axioms, such as, the belief that stocks are the best long-term investment. He discredits financial reportage, limns to the psychological and emotional factors that make markets behave irrationally and proves that nothing is new about "new economy" prattle. The book is a very effective vaccination against the costly virus of credulity. We [...] suggest this book for every investor's shelf - dog-eared and worn from frequent re-reading.

I was disappointed in this book. From the title, I thought the book would address the systems dynamics of an inflated stock market and how those would probably unwind. While the book takes an overview crack at what some of those systems dynamics factors might be, one looks in vain for a model or argument tying them together. As a result, I left the book feeling like a knew almost nothing more than I did when I started.
The new material was all based on the author's interviews with investors to determine how attitudes and behavior have been changing. While that was interesting, it did not take me where I want to go: When will this market end and what is the aftermath likely to look like? If that is your question, do not buy or read this book.
I thought that many obvious factors in the current high valuations for technology stocks were missing from his argument. For example, many high tech IPOs have severe restrictions on how much stock can be sold and when. This creates a situation where 1000 buyers exist for every seller in the early days. Some of these stocks in 1997-2000 have been trading the outstanding float more than 200 times a year! Obviously, as these lock-ups end, the companies sell more stock, and original investors sell more stock, the supply and demand will come into balance at much lower price levels. Even an economist should notice something like that!
The wealth effect of a rising market gets short shift in this book. A high market makes companies and people wealthier. As a result, they spend more than they would otherwise. This expands the economy more rapidly, pushing sales and earnings growth at a faster pace. When that happens, investors will pay higher multiples for current performance because that performance is expected to grow more rapidly in the future. Clearly, a lot of the current market's price level is affected by this phenomenon.
Another missing point is the role of the Federal Reserve in expanding the money supply very rapidly since 1997 until early in 2000 as a response to the worldwide currency crises (and more recently to fears of Y2K). When the Fed gets through pumping all of this money into the economy, most of it has to flow into financial assets. There isn't that much need for more tangible assets. A lot of what has happened recently (1997-1999) is simply a function of a Federal Reserve that has been pushing too aggressive of a monetary policy.
I can go on, but you get the idea. The author seems to be missing the big picture.
Now let's consider the little picture. Nine stocks out of 10 are trading in a valuation pattern that is quite consistent with how they have been valued for the last 20 years based on our research at Mitchell and Company. How can that be viewed as irrational exuberance?
Almost every new industry has had a period of extremely high stock-price valuation. I assume the author remembers what happened with radio, tv, and biotechnology stocks earlier. These periods of over-valuation usually last 5 years or less. They usually end with a string of disappointments in growth and/or profitability. This Internet-led boom (both dot com and infrastructure suppliers) will probably be the same. That may not sound very grand, but that's mostly what is going on now. I am astonished that this aspect was not highlighted and modeled in an effective way.
Basically, the book's idea is an interesting one but the book has the wrong author to do it justice. He did produce a book filled with various economic data that you may not have seen before. That's the positive side of this book, especially the behavioral economics data.

The current importance of Professor Robert J. Shiller's prescient publication in March 2000, right near NASDAQ topping out around 5000, is to see what relevance it has for us today. He begins with 12 factors he believes played a major role in creating the bull market/boom/bubble of the late 1990s, and ends with an assessment of which of those 12 will continue to play an influential role going forward. That, too, should be our concern.
First, let me say that his deconstruction of the "efficient market theory" probably has more lasting importance in the financial world than his assessment of whether we had an overvalued stock market, and should be taken to heart by everyone who wants to make money in the stock market. In over a decade as a member of two securities exchanges, I never found any evidence that the random walk or efficient market theories had any significance in real world finance. An ivory tower construct, for sure.
Prof. Shiller's 12 reasons for the 1990s boom and their current/future influence:
1. The Internet: It remains a viable growth engine, but got ahead of itself. The Internet continues as a strong influence on business and the stock market.
2. Decline of foreign competition: Our victory over communist economies is waning. New competition (China) will emerge on the world scene.
3: Pro business culture: Could easily turn against the market.
4. Pro business governmental policies: Could easily turn against the market.
5. Life cycles - Baby Boomers: He expects the positive effect to diminish.
6: Financial press reporting: Probably will continue but not show much growth.
7: Optimistic analysts: Can easily turn negative.
8: Retirement plans: Social Security is a potential plus if redirected into stocks.
9. Growth of mutual funds: Difficult to ascertain.
10: Decline of inflation: Can't get lower; can only get worse.
11: Day trading/increased public participation: Likely to continue. More people's access could elevate prices.
12: Rise of national gambling culture: He admits the connection between gambling and the stock market is weak.
Prof. Shiller is pro-markets. His concern is whether outrage over the bursting of irrational bubbles might do irreparable harm including turning our society against our capitalistic and free-market institutions. On this point he eloquently states, "Speculative markets perform critical resource-allocation functions (a point I have taken for granted and have not focused on in this book), and any interference with markets to tame bubbles interferes with these functions as well. Ultimately, in a free society, we cannot protect people from all the consequences of their own actions. We cannot protect people completely without denying them the possibility of achieving their own fulfillment. We cannot completely protect society from the effects of waves of irrational exuberance or irrational pessimism - emotional reactions that are themselves part of the human condition." (p233).
Perhaps this is why under the subject of what role government might play in cooling down irrationality before it becomes destructive, I did not notice any reference to the FRB's role of setting margin rates on stock purchases. This power (Reg T) was created precisely to cool down speculative markets when they get too hot. Greenspan, for whatever reason, chose not to invoke this tool during the boom.
In the end, Prof. Shiller blames investors for their blind exuberance and predicts more difficult times ahead. Indeed, his fears have been borne out the past 3 years. But even he does not rule out another run based on new factors and old psychology because not only is it human to err, but also it is human to be irrational. The solution? In his words, "It may be that the best stabilizing influence on markets is to broaden them, allowing as many people to trade as often as possible." This is why in his next book, "The New Financial Order: Risk in the 21st Century" (2003) (see my review), Prof. Shiller confronts how government and society can work together to mitigate future emotional disruptions to our everyday lives through market-based instruments.

Shiller's historical review of markets brings the reader to the question: Is there such a thing as too high a price? Many investors today believe there is not -- in fact, it has become the conventional wisdom. "Buy stocks regardless of the price because they always go up". Shiller's historical evidence is that people have thought this once every generation or two in the past. In the past they have always been disappointed.
Shiller is not a raging bear as pundits have labeled him. He is not predicting another depression. His assertion is simply that when prices are high it is unlikely to be a profitable time to invest compared to investing when prices are low.
The thinking that we are in a "new era" permeates today, as he shows it has during previous market peaks. And although "new eras" do revolutionize the way we live, they have never ended the economic principle of competition preventing any enterprise from earning extraordinary profits for long. (Is the internet really a greater revolution than the invention of electricity? of the telephone? of affordable cars?)
There is no such thing as a risk free, predictable and effortless way to great wealth. Shiller provides a thoughtful examination of why from time to time it appears to people that there is such a thing and compares "what were they thinking then" to "what are we thinking now" with good effect.
A long term perspective, thoughtfully presented in a very approachable style.

Shiller points out the factors contributing to the biggest bull market in U.S. history, which by now are obvious to nearly everyone. However, if you're in want of technical, quantitative research, you'll be disappointed. Shiller relies on market inefficiency to advance his argument, but makes his case with more "squishy" arguments, and writes at length about behavioral and psychological factors. His concept of a "cascade of information" that contributes to long-term bull or bear trends is especially interesting.
Shiller debunks market efficiency by pointing out that Malkiel, Fama and the rest of the new finance crowd depend on the concept of the rational investor seeking the efficient frontier. Shiller gives us plenty of reason to believe that the majority of investors in the stock market are not rational at all (and often completely idiotic).
Disturbingly, however, Shiller winds up his treatise by taking pity on the fools that were dumb enough to pay $200 for Yahoo! and engages in a rather unbecoming of flailing and hand-wringing about what should be "done" about a stock market bubble. That is, what should the GOVERNMENT do about NASDAQ 5000?
This spoils the book. The answer, clearly, is that the government (Shiller uses the more benign term "public policy) should not care one iota about the stock market in a capitalist system. The fact that the question was even raised left a horrible taste in my mouth and induced me never to buy a Shiller book again.
In any case, it's bound to become a classic for its timing (March 2000) more than any other reason and is certainly worth a read.

By Young Lee

The first impression I got from reading this book was "Who is this author? How did he predict all that?"
Robert Shiller, the author of this book, must have spent incredible amount of time researching statistics for data and professional psychology. As the pages go on, I guarantee that readers must be dumbfounded by his expectations on after year 2000.

The book itself was easy to read and flexible to follow the data and chart Shiller had provided. I enjoyed reading it and learned not only the economic sense of stock market itself, but also the trend (history) of the market and its relevance with people's psychological minds. I do not suggest this book to anyone who is looking for "how to make tons of money from stock market" type of books. This book actually discourages people from hastily joining in investments. It helps and makes you to be very determined to carefully study the overall stock market.

To briefly explain the synopsis of this book, the author starts with explaining how "irrational exuberance" came out. The words "irrational exuberance" was first used by Alan Greenspan, the chairman of the Federal Reserve Board on December 5, 1996. Right after the moment he uttered these words out, the world's various stock markets reacted precipitously: most of each country's stock indexes dropped by 2 ~ 5%. Now the words have become a name for a social phenomenon when markets have been bid up to unusually high and unsustainable levels under the influence of market psychology. There are several periods of irrational exuberance throughout the stock market history. The Great Depression era in 1920s, the dramatic run-ups and downs from late 1950s to early 1960s, the stock market debacle of 1973-74, and the most dramatic price boom of 1990s are the examples. Shiller provides a chart that shows the relationship between the stock market level and the market's earnings (price-earnings ratio). Considering the fact that GDP increased only 30% and corporate profits increased by less than 60% when the stock market level tripled in 1990s, Shiller warns the readers. The price-earnings ratio of 1990s is higher (44) than that of just before the Great Depression (33). Also, the S&P dividends in 2000 are 1.2% of the price, which over the history average about 4.7%. Shiller then provides another chart that shows price-earnings ratio and its 10 year real returns, and it shows that from year 2000, there would be negative returns over the next 10 years.

Throughout the book, Shiller gives out several data and chart to support his opinion. It may be difficult to grasp those at first, but as you read through it, most of them can be easily grasped. The vocabulary and structure of this book is also not that difficult. Personally, it was like reading through a very long news paper opinion (but interesting). For example, he would explain a theory, provides some evidence that oppose the theory, and finalizes the chapter with his original thought on why the theory is fault.

I really liked how he linked people's psychology with the stock market. In chapter 8, he explains about herd behavior and epidemic. People's communication of "They said that" or "I heard that" can influence unexpected number of other people to join the market. I can see how it can be related because not only with the stock market, people tend to act or do not act by observing other people's reaction in our daily lives.

Overall, it still amazes me that right after he wrote this book, the stock market crashed. Robert Shiller had gained my full respect for his research and confident expectation that eventually came out. I recommend this book to anyone who has interest in stock market, and I would suggest this quote from the book, "People still place too much confidence in the markets and have too strong a belief that paying attention to the gyrations in their investments will someday make them rich, and so they do not make conservative preparations for possible bad outcomes."

Shiller explains why the incredible 225% increase in the Dow Jones Industrial Average from the beginning of 1994 through the end of 1999 was unsustainable: "as a rule and on average, years with low price-earnings ratios have been followed by high returns, and years with high price-earnings ratios have been followed by low or negative returns." Writing in 2000 when the price-earnings ratio on the S&P500 was nearly 45, compared to a long-run average of about 20, Shiller was preparing us for a bursting of the stock-price bubble. His message was sobering and prescient then as well as good education now. Caution: the reader will have to whack through thickets of details in Chapter 1 such as "The average real return in the stock market (including dividends) was -2.6% a year for the five years following January 1966, -1.8% a year for the next ten years, -0.5% a year for the next fifteen years, and 1.9% a year for the next twenty years."

In Part 3: Psychological Factors, Shiller outlines principles of behavioral finance. For example, past prices and stories help form people's views of the stock market. He reviews classic experiments in psychology, which documented the significance of peer pressure and trust in experts. Shiller's interpretation is that people take uncritically what experts on the stock market offer, presumably that stock prices will continue to rise, which encourages them to be overconfident.

The author puts forth a good explanation of efficient markets theory but applies much criticism. He proclaims: "I see no reason to doubt the thesis that smarter people will, in the long run, tend to do better at investing." Reading and understanding Irrational Exuberance will help put the individual investor in the company of those "smarter people."

This book is about asset bubbles in general and particularly the US stock market around year 2000, written and published shortly before the crash. The author uses several statistics to show that the market was very overpriced. There are also several statistics of past bubbles and various historical insights, anecdotes and news clippings. I found the book interesting and easy to read. The only parts of the book I don't like are the discussions about the causal nature of bubbles which read like longwinded conjecture.

'Irrational Exuberance' will no doubt consolidate Robert Shiller's position within his chosen field, but the book is also of considerable value to the intelligent lay person. Other writers have drawn attention to the market's overpriced level. Other writers have also done the numbers and concluded that stock returns are not likely to out pace bond returns, for example, over the next decade. But no other writer provides such a detailed and convincing analysis of the factors that have stoked our mania for stocks and brought us to the top of a speculative bubble. Shiller's account of what academics such as Prof. Irving Fisher thought of stock market valuations in the 1920s is a useful reminder that even the experts can get it wrong. More importantly, his analysis of past decades suggests a cyclical movement in the all too human desire to believe in a new economic age. Among the truths which Americans evidently have not learned is that new economic eras do not result in permanent stock market booms. That technology enables more efficient production which in turn helps keep inflation low has been acknowledged publicly by Alan Greenspan. But the market's reaction extends way beyond what this fundamental change might warrant, for all of the reasons Shiller cites.
While Prof. Shiller's analysis is highly credible, his suggestions for the individual investor are, in places, difficult to understand. Indeed his discussion of diversification may only be deciphered by his fellow economists. Lay men and women can hardly be expected to know what "...taking short term positions in claims on income aggregates," means. Nor can they regard his advice to invest in markets that do not yet exist as practical guidance. These, however, are minor quibbles. Unlike many market commentators these days, Shiller's underlying social conscience puts him on the side of the little guy. Yet even so, this books is aimed primarily at policymakers who have the power to influence public behavior for the good. The prospect of thousands of retirees living on the margins because they invested too much of their 401(k) money in the stock market is surely one which will compel their attention.
Jim Sanders Annandale, Virginia

While reading this book, I was reminded of the three laws of thermodynamics:
The First Law: You can't get anything without working for it.
The Second Law: The most you can accomplish by working is to break even.
The Third Law: You can only break even at absolute zero.

Most engineers can recite something a little more down to earth:
1) You Can't Win.
2) You Can't Break Even.
3) You Can't Quit.

Dr. Shiller does a good job of arguing our investment portfolios, on average, must obey laws 1 and 2, but suggests we can escape law number 3. I'm not convinced

The book starts very well, documenting a strong historical relationship between 10 year annualized growth and the ratio of 'stock price' divided by either earnings or dividends. He covers this material several times, and always makes good use of it. In short, the high price-earning ratios of 2000 were not sustainable. The title argument is proven in chapter 1.

The middle of the book is occupied by less compelling material. First, we review what Shiller called structural factors. These are facts such as the Internet and baby boomer demographics. This includes a detour into popular delusions caused by our natural tendency to get excited by the enthusiasms of others, honest or otherwise. Next, we cover what Shiller calls 'cultural' factors: news, popular concepts (both high-brow and faddish). Not willing to rely on these simple distinctions, Shiller call psychology a 3rd area of interest. In this section he covers what might be called 'behavioral finance' (psychological anchors and herd behavior).

Much of this is fascinating material and highly recommended. Unlike chapter 1, the implications are somewhat vague.

Finally, after reviewing what amounts to thermodynamic laws 1 and 2 applied to average investment portfolios, Shiller concludes the government can do a better job. Very specific comments on Social Security reform dominate the final chapter. Unfortunately, none of the book lays any foundation for his policy advocacy (he hates privatization). I suspect one's political persuasion will determine how one reacts to the argument, since there is almost no background or survey of policy options provided. For me, the sudden change in paces was an attempt to change the subject and avoid talking about thermodynamic law #3.

New Haven's Robert J. Shiller, is a highly regarded expert on market volatility. Shiller chose Alan Greenspan's term "irrational exuberance" for the title of this book alluding to the trend of stock market highs and the frame of minds lurking in the background that propagated that trend. What goes up must come down eventually. I see three statements regarding this grizzly business surfacing in this book. He addresses historical and social foundations for current trends. Secondly, he renders warnings on privatization and ill investments of Social Security and private retirement funds as opposed to plans that minimize risk-management principles and lastly Mister Shiller constructs a reassessment of investment principles and alternatives for the future player. The emergence of information at our fingertips via the Internet and an never ending trend in television, newspaper and radio news to over editorialize the actual events like chocolate shots covering a vanilla cone distort and gloss over every aspect of our lives today. Are we going to have another `storm of the century' or will the skies be sunny and warm tomorrow? Your guess is as good as mine. I think that is the point that Shiller is making in his book. What goes? Anything that makes you feel good for the next 15 minutes and don't think beyond that. I think we are headed for that place down below in a hand basket but I don't want to think too far ahead.

Buy this book. Read it (quickly). Put it on the shelf on top of G&H's "Dow 36,000". Why? In the years to come, this is the book that is going to have or give the name to the current age.
This book is a fun read because it is not a tour-de-force of fine and detailed research that mark the author's excellent work on volatility. However grand the phrase, "Irrational Exuberance", Shiller's task is also too grand, and he admits, that it is not possible to *prove* the assertion of speculative excess. For those looking for an alternative explanation of how markets may reach valuations consistent with a "new era" thinking that is divorced from the standard equations, here it is, written as well as it might be, probably.
Nevertheless, for those looking for an answers to the following questions, it might leave you thinking your evening was misspent: (1) Are we currently in a speculative bubble? (2) If so, how much is the market overvalued?
Even if one admits that speculative bubbles are possible (rational or irrationally motivated), it is still hard to offer to give an ostensive definition of one, separate from the (trivial?) observation that prices subsequently fell an "exceptionally" large amount, so the prior markets must not have been "rationally" priced.
This is, of course, somewhat unsatisfying. Even more so since Shiller admits that the current tools to cope with bubbles (moral suasion, monetary policy, trading curbs, etc.) are ultimately ineffective against the powerful media and psychological forces that lead to resource-allocation inefficient speculation. In this sense, one might coyly opine that, "Those who know history, are condemned nevertheless to repeat it." How sad. To be fair, though, there are some advice gems hidden in the text, under a subtitle, "What Should Investors Do Now?" Sounds sound to this reviewer.

It seems as if Shiller, an Ivy league professor, is more interested in displaying his literary talent than writing cleary for the average reader. For example, beginning the third paragraph on page 144 under the topic, "Overconfidence and Intuitive Judgement", Shiller writes, "Economists Nicholas Barberis, Andrei Schleifer, and Robert Vishny have developed the representativeness heuristic into a theory of investors' selective overconfidence and into a psychological theory of an expectational feedback loop." What?! Many more places in this book are written just as abstractly. I'll admit that I am not an A+ English student, but if Shiller wants to get his point across he'll need to write his book for the average reader. The "Bear Book", by John Rothchild is more convincing and much easier to comprehend than Shiller's book.

If you believe Shiller was prescient in early 2000, take note that a second edition is in the works, and he adds his concerns about current real estate valuations this tiem around. From CNN article on 8/12/04:

>>.... "I would say a bubble is happening," said Robert Shiller, whose book "Irrational Exuberance" (Princeton University Press, 2000) warned, correctly, that the stock market was grossly overvalued by investors' unfounded optimism. "When it's going to burst is the real question," he said. "It's difficult [to know]." The Yale economist and principal at real estate firm Fiserv Case Shiller Weiss is now working on the book's second edition, which will among other things look at whether America's obsession with the stock market has been displaced by exuberance for real estate. During a housing bubble, he said, buyers who would otherwise consider a house too expensive go ahead and buy anyway because they overestimate future price appreciation and underestimate risk. The bubble bursts, or deflates, when buyers are no longer so sure that prices will continue to increase. "The essence of a bubble is investor enthusiasm," said Shiller.

Irrational Exuberance 2nd Edition

Robert Shiller is at it again. After the timely release of his original Irrational Exuberance just one month before the stock market crash in 2000, he's back with the 2nd edition. The entire second chapter is an attack on the runaway housing market.

A main theme is how bubbleites or bubble-addicts, not being able to live without the thrill of participating in a runaway market became disheartened with the slumping stock market and headed to real estate.

Yes, it's a very interesting book, a bit scary; proclaiming the stock market is still vastly overvalued and the housing market could fall apart at any minute. He points out that real (inflation-adjusted) PE ratios are at the highest point (with the exception of the 2000 peak and the 1929 peak) on the S&P Composite Index when going back to 1860, and how real, (inflation-adjusted) home prices have only appreciated an average of .4% over the last 114 years.

If you Google Robert Shiller you come up with hundreds of articles discussing the housing bubble with his comments. Last week I read him saying the housing market could take a 50% clipping in some areas.

One thing is for sure, if the housing market pops in the near term he will have called two major bubbles within 5 years and will become the famous bubble boogie man.

By Kevin Kingston, author of: A 20,000% Gain in Real Estate

(...)

Having read Irrational Exuberance these are a few subtitles that come to mind. The real historical truth about investing for the long term. What Financial Advisors, Fund Managers and Brokers will probably never tell you or talk about. Let reality be your guide when deciding how much and for how long you should invest, and The true nature of the stock market a revealing look at its hundred and twenty nine year history. Let me now share with you some examples of the important information you will find in this book. This book dispels the notion that is currently touted that long term investing, five, ten, fifteen and twenty years will result in an average annual return between ten and twelve percent. If you take the period Sept 1929 and add fifteen years (Sept/1944) your average annual return would have been -0.5%. This same return was obtained if you take the period Jan1966 and add fifteen years (Jan 1981). Now add twenty years to Jan 1966(Jan 1986) and your average annual return would have been 1.9%. A full explanation and more data on historical returns are found in chapter one. How about this for an eye opener (the second highest price earnings ratio of all time 32.6 by June of 1932 the market lost 80.6%). The S&P composite index did not return to its Sept1929 value until Dec1958 (29.25 years). Well, you can rationalize this by saying that was a long time ago but " real prices bounced around near their Jan1966 peak surpassing it somewhat in 1968 but then falling back and real stock prices were down 56% from their Jan 1966 value by Dec 1974". "Real stock prices would not be back up to their Jan 1966 level until May of 1972 (26.33 years)". The cause of stock market bubbles: precipitating factors, cultural factors and psychological factors are explained and discussed in this book's other chapters. If you compare Harry S. Dent's book "The Roaring 2000" copy write 1998 there are no footnotes, none of the facts are referenced regarding source of information, completely the opposite of Robert Shiller's book. All his data is fully referenced and researched. Mr. Shiller also discusses and points out weaknesses in several popularized books over the last few years. Here is an interesting fact in from 1921 to 1929 the market tripled in 9 years " the Dow Jones Index was 3600 in 1994 by 1999 it was 11000, it more than tripled in five years." "Yet basic economic indicators such as US personal income and gross domestic product rose less than 30% but if you factor in inflation the amount is closer to 16%". This book is written objectively, dispassionately and with humility. Mr. Shiller acknowledges his limitations and certain exceptions to the rule. What I would have liked to know is the historical low price earnings ratios of the last hundred and twenty-nine years? What price earnings ratio would be considered fair value for the market? What range of low price earnings ratio would be considered a good buying opportunity? There is a chapter on new era thinking that draws certain parallels between the 1920s, 1950s, 1960s and 1990s, which is fascinating and gives pauses for sober reflection. You will come to realize that the rhetoric from the past is quite similar to the present. Another interesting parallel is found on page 179 between Edwin Land (Polaroid) and Bill Gates (Microsoft). Polaroid's price earnings ratio was 94.8, starting with 1972 over the next twenty-five years Polaroid under performed the market on average 11% per year (if the market returned 21% Polaroid returned 10% per year). There is data regarding long periods when the stock market returns under performed short-term interest rates and bonds as well as evidence showing stock market prices have a life of there own (dividends and earning do not have a direct relationship to stock market prices). The final chapter contains what investors should be doing now and why. I consider this book to be one of the most important books of the 21st century. It profiles the market superbly.