[extropy-chat] Housing bubble looking good
hal at finney.org
Thu Mar 9 22:03:00 UTC 2006
Damien Sullivan writes:
> By contrast there's the anecdote of the 1929 tycoon who pulled out of the
> stock market when his shoeshine boy started giving him tips. "No more fools
> to pull in, time to sell."
I do hear this kind of thing a lot when I tell people about markets.
Certainly 1929 is a notorious failure to anticipate the future, and
there are many others. I have occasionally seen revisionist analyses
which try to show that many infamous market bubbles and failures were
actually not as bad as people think, but still it is clear that markets
have not done well at forecasting unexpected events. Of course that
is a bit tautological since if the events were forecast by the markets,
they would have been expected.
One book I've been reading is The Wisdom of Crowds, by James Surowiecki:
It's a pretty good book, a bit anecdotal and breezy, but he has some
interesting ideas about when "the crowd" can be expected to provide
good information and when problems can arise. One way things can go
wrong is if people start paying too much attention to the consensus
instead of thinking for themselves.
For example, suppose you ask a classroom of students to guess how many
jelly beans are in a jar. If you have everyone write down their guess
and then you average them, they usually come pretty close. It's a big
surprise to most of the class, according to Surowiecki. However if
you have the first person say his guess out loud, then the next, then
the next and so on, the results tend not to be so close. What happens
is that people hear what others are guessing, and they mentally adjust
their own estimate to take into consideration what everyone else thinks.
Suppose by coincidence the first few guessers were too high (or suppose
that the teacher has "salted" the class with stooges to make sure this
happens!). Then the next few people may revise their guesses upwards
a bit, thinking they were too low. The more people do this, the more
powerful the effect becomes. The result is that the whole class can
become trapped in a false guess just because the first few were off.
You can see how this can apply to markets. People don't just make
up their own minds, they adjust their opinions when they see what
the consensus is. In fact the other day I argued that from a certain
point of view, rationality almost forces this. But, the unfortunate
thing is that if this happens too much, the market won't work well.
If everyone just agreed with the market price, then the price would have
no connection to reality. So ironically, for markets to work right,
people have to partially ignore the information they get from the market.
Markets ultimately depend on people being irrational in this sense.
This can provide an explanation for market bubbles and crashes, where
people were relying too much on information from the market price itself
and not bringing enough of their own insights and information from the
rest of the world into the market. The market will consolidate and
integrate all the information available, but only if people bring that
information to the market.
The good thing is that the market constantly dangles that carrot out there
of great riches, if you do have some private information that contradicts
the market consensus. So people still have incentives to take positions
based on their information and move that market price in the way it
ought to go. The question is whether this incentive is strong enough to
overcome the tendency to be fooled by an apparent market consensus.
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