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美国本特利大学经济学教授斯科特·萨姆纳(Scott Sumner)






Are bubble theories fools gold? Or successful alchemy?  

2009-05-21 10:26:55|  分类: 默认分类 |  标签: |举报 |字号 订阅

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Are bubble theories fools gold? Or successful alchemy?

There’s been a lot of buzz in the blogosphere recently about attempts by Brad DeLong and Paul Krugman to develop models of asset bubbles.  I can’t blame people for trying; we’d all like to understand why we keep getting these crazy price peaks in tech stocks, oil, housing, etc.  But as you may have already noticed if you read my EMH post, I am somewhat skeptical.  Today I’d like to look at this question from several different angles, starting with a question:

What’s the point of bubble theories?

This is not a rhetorical question; I am actually pretty ignorant of bubble research, and am hoping a reader can fill me in.  My initial thought is that the point of bubble theory is to explain why bubbles happen.  And doesn’t that mean you would have to be able to identify bubbles in real time?  And doesn’t that mean your theory would have to be able to provide useful investment advice?  I’m thinking of something along the following lines:

Imagine a model that predicts the optional allocation between index stock funds and Treasury bonds, based on two factors; years to retirement and level of stock market relative to what your model suggests is some sort of “fundamental value.”  The percentage allocated to stocks should be positively related to years to retirement and negatively related to the ratio of stock prices and fundamental values.

Is that what bubble theories should produce?  And if not, are there any practical implications, or are they simply “just so stories?”  I vaguely recall reading that there are “rational bubble” theories, and/or bubble theories that don’t imply it is easy to beat the market.  But surely there must be some practical implications; otherwise what’s the point?

For the rest of this post I am going to assume that the point of bubble theories is to find deviations from EMH that have at least some useful implications for financial investment decisions.  (If I am wrong, stop reading now and don’t waste any more time.)

Here’s my next problem with bubble theory; the discussion in the blogosphere is not related to rocket science, it is not related to the sort of sophisticated math used to explain options pricing, rather Krugman suggests that what is being discussed are theories about psychology:

Brad DeLong offers a neat little model of speculative fluctuations in asset prices, based on the idea that investors gradually switch strategies based on what seems to work for other people: if people buying stocks seem to be doing well, more people move into stocks, driving up prices and making stocks look even more attractive…

But aren’t sophisticated mathematical models the only area where academics might even conceivably have a comparative advantage?  I would think that psychological theories are where you would expect savvy Wall Street investors to have a comparative advantage over academics.  I would be intimidated by the thought of modeling bubbles; I would think someone like Warren Buffett would be far better than me at intuiting market irrationality.  Yet even Buffett lost about 30% in the market last year.  How the h*** am I going to see something that he missed?  And not just Buffett, but 1000s of other sophisticated investors who also lost a fortune.

When I first started working on this post I was trying to think of the right metaphor for a hopeless search; the search for the Holy Grail, the fountain of youth, Presbyter John, the alchemist’s formula for gold, etc.  Then I realized that the alchemy metaphor had an interesting double implication.  To see why, let’s imagine Krugman and DeLong succeed in their quest; what next?  It seems to me that there are two possibilities:

1.  They keep it secret.

2.  They publicize it.

Here is my prediction; they will never get the recognition they deserve for succeeding, even if they are successful.  Why?  Because the theory will only be useful if it is kept secret, but in that case the public will never know that they succeeded.

Rorty famously argued that “truth is what my peers let me get away with.”  I know most people don’t like that sort of post-modernism; but can we at least agree that “what is considered truth is what your peers let you get away with.”  In other words Krugman and Delong will have to convince their peers that their bubble theory is correct.  But if they do, if it becomes generally accepted that a particular asset price model is superior to the EMH, why wouldn’t the advantage of that model go away?  We know Wall Street types feverishly look for any tiny advantage that would allow them to earn above average returns.  It seems to me that any generally accepted theory of asset prices would immediately become incorporated into asset prices.  But in that case it would no longer predict.  And then their idea would be discredited, after all, it’s easy to fit a bubble model to past data.  If it doesn’t predict future data, nobody will care.  It will be like those market “anomalies” that go away after being publicized.  And this is what is especially interesting to me—the bubble model would become discredited even if they were in a sense “right.”  (By “right,” I mean that had they kept the idea secret, the model would have continued to perform well.)

On the other hand if they keep the model secret, they can become (somewhat) rich.  But not for a very long time, as not even the anti-EMH types think the market is so inefficient that it is easy to quickly gain riches.  If it was merely a choice between academic glory and riches, then we would expect any serious academic to go for the glory (unless they already have a Nobel prize.)  But that’s not the choice; there is no strategy that leads to academic glory.

By now you may have noticed that this is roughly the quandary that faced medieval alchemists.  We now scoff at their foolishness, as they clearly did not succeed.  But I’d like to offer a contrarian view.  How do we know they didn’t succeed?  A formula to turn lead into gold has zero value if it became public.  Patent protection was weak, and presumably the lead into gold transformation industry would have been a competitive constant cost endeaver.  So even if some obscure alchemist had succeeded, we never would have heard about it.  Have you ever wondered how the Bank of Switzerland ended up with so much gold?  Just asking . . .

Now let’s turn to the motivation for the search—real world asset price bubbles.  Arnold Kling discusses one famous stock bubble, and ends with this observation:

Incidentally, one thing I got from reading Galbraith’s book on financial euphoria is that you can fit the late 1920’s into this model. Holding companies bought stocks, and the holding companies were bought by other holding companies, and so on. You get the spectacular leverage, and on the way up people think that the assets of the holding companies are pretty low risk. Then when people get a little nervous…

Let’s consider the innocuous phrase “then when people got a little nervous.”  Why might people have gotten a bit nervous in late 1929?  Maybe because after the best two year period in American macroeconomic history (from an investor perspective), the stock market was suddenly flooded with a torrent of bad news.

In the two years prior to the October crash the U.S. economy grew rapidly with slight deflation.  This was highly desirable as gold was undervalued after WWI and there was a long term deflation risk that needed to be carefully managed.  There were also low marginal tax rates, Federal spending was 3% of GDP, we had budget surpluses, trade surpluses, pro-business Republicans controlled the Federal government, unions were weak, unemployment was low and corporate profitability was rising fast as new technologies were transforming American industry.  Stocks would not have been overpriced if the Depression had been avoided.

Then everything went wrong:

In late October the Attorney General announced a crackdown on mergers—which is always bad news for stocks.

The Republican Party in Congress tore itself apart in a bitter fight over the Smoot-Hawley tariff.  Hoover’s political ineptitude became painfully obvious.  This was the headline story around the time of the crash.

The political situation in Europe (which had been improving), suddenly worsened dramatically with the death of German statesmen Stresemann and the unexpected gains made by German “nationalists” in a referendum on the war debts issue.

And most importantly, the world’s major central banks suddenly and simultaneously adopted highly contractionary monetary policies.  This led to a rapid rise in the world’s gold reserve ratio after October 1929; a highly deflationary policy stance.

What is particularly interesting is that 3 of the 4 factors that would cause the Great Contraction (tight money, Smoot-Hawley, and international discord preventing policy coordination) all reared their ugly head in the period from late September to late October 1929.  (The last factor, banking crises, wouldn’t begin for another year.)

So here’s my question: Should we encourage young economists to do careful study of historical events like the crash of 1929, looking for rational explanations of what initially appeared to be irrational events, or should we encourage them to think up neat new psychological theories of stock bubbles?

George Bittlingmayer came up with the theory that the change in merger policy contributed to the crash, but the rest of it I developed on my own.  (And you already know about my theory of the crash of 2008.)  If an obscure professor at Bentley can come up with a plausible rational model of the 1929 bubble, then imagine what we could expect from professors teaching at places like Princeton and Berkeley.  Arnold Kling gave some advice to DeLong and Krugman.  If I’m not being too presumptuous, I’d advise them to give up trying to turn lead into gold, and start working on the laborious process of trying to extract nuggets of rational behavior from seemingly barren mountains of perplexing economic data.  There’s less instant gratification, and there are no short cuts to wealth, but the satisfaction it produces is deeper and more long-lasting.

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