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SHILLER, Robert J.

Irrational Exuberance

Chapter 1



Irrational exuberance is the psychological basis of a speculative bubble. I define a speculative bubble as a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increases and bringing in a larger and larger class of investors, who, despite doubts about the real value of an investment, are drawn to it partly through envy of others' successes and partly through a gambler's excitement. We will explore the various elements of this definition of a bubble throughout this book.

Greenspan's "irrational exuberance" speech in 1996 came near the beginning of what may be called the biggest historical example to date of a speculative upsurge in the stock market. The Dow Jones Industrial Average (from here on, the Dow for short) stood at around 3,600 in early 1994. By March 1999, it passed 10,000 for the first time. The Dow peaked at 11,722.98 in January 14, 2000, just two weeks after the start of the new millennium. The market had tripled in five years. Other stock price indexes peaked a couple of months later. In the years since, as of this writing, the stock market has never been so high again. It is curious that this peak of the Dow (as well as other indexes) occurred in close proximity to the end of the celebration of the new millennium: it was as if the celebration itself was part of what had propelled the market, and the hangover afterward had brought it back down.

The stock market increase from 1994 to 2000 could not obviously be justified in any reasonable terms. Basic economic indicators did not come close to tripling. Over this same interval, U.S. gross domestic product rose less than 40% and corporate profits rose less than 60%, and that from a temporary recession-depressed base. Viewed in the light of these figures, the stock price increase appears unwarranted.


I thought in 2000 that most people I met, from all walks of life, were puzzled over the apparently high levels of the stock market. It seemed that they were unsure whether the market levels made any sense, or whether they were indeed the result of some human tendency that might have been called irrational exuberance. They seemed unsure whether the high levels of the stock market might have reflected unjustified optimism, an optimism that might have pervaded our thinking and affected many of our life decisions. They seemed unsure what to make of any sudden market correction, wondering if the previous market psychology could ever return.

Even Alan Greenspan seemed unsure. He made his "irrational exuberance" speech two days after I had testified before him and the Federal Reserve Board that market levels were irrational, but a mere seven months later he reportedly took an optimistic "new era" position on the economy and the stock market. In fact, Greenspan was always very cautious in his public statements, and did not commit himself to either view. In the public exegesis of his remarks it was often forgotten that, when it comes to such questions, even he did not know the answers.

Years after the 2000 peak of the market, the market is down significantly, but still is very high by historical standards. The news media are tired of describing the high levels of the market, and discussion of these levels is usually omitted from considerations of market outlook. And yet, deep down, people know that the market is still highly priced, and they are uncomfortable about this fact.

Lacking answers from our wisest men, many are inclined to turn to the wisdom of the markets to answer our questions, to use the turns of the stock market as fortune tellers use tea leaves. But before we begin assuming that the market is revealing some truth about this new era, it behooves us to reflect on the real determinants of market moves and how these market moves, in their effects, filter through the economy and our lives.

Many of those real determinants are in our minds. They are the "animal spirits" that John Maynard Keynes thought drove the economy.14 These same animal spirits drive other markets, such as the real estate market, to which we now turn as another case study of speculative behavior, before we begin our analysis of the causes of such behavior in Part I of this book.