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  • Professor Robert Shiller: Today's lecture is about

  • behavioral finance and this is a term that emerged into public

  • consciousness around the mid-1990s;

  • before that it was unknown. The term "efficient markets" is

  • much older; I mentioned the idea goes back

  • to the nineteenth century and the term goes back to the 1960s.

  • But behavioral finance is a newer revolution in finance and

  • it's something that I have been very involved with.

  • I have been organizing workshops in behavioral finance

  • ever since 1991, working with Professor Richard

  • Thaler at University of Chicago. We've been doing that for

  • eighteen years; amazing, that's a long time for

  • you, right? When we started we were total

  • outcasts, we thought; nobody appreciated us.

  • I had tenure so I could do it but the problem is,

  • you don't want to do things that are too out of fashion.

  • Fortunately, we have a system that allows it

  • to happen and I'm very happy to have that.

  • What behavioral finance is a reaction against extreme--some

  • extremes--that we see in efficient markets theory or also

  • in mathematical finance. Mathematical finance is a

  • beautiful structure and I admire what the people have done and

  • I've worked in it myself, but it has its limits.

  • Eventually--you know the way a paradigm develops--it goes

  • through a certain phase. When mathematical finance was

  • new, say in the 1960s, it was the exciting thing and

  • nobody wanted to work on anything else;

  • you wanted to be doing the exciting thing.

  • As the '70s and '80s wore on, it got to be a little bit

  • overdone; people run with it too far,

  • they think that's all we want to do, and we don't want to

  • think about anything else. Then they start to get

  • sometimes a little crazy. Than we had to reflect that,

  • well, things aren't perfect. The world isn't perfect and we

  • have real people in the world, so that led to the behavioral

  • finance. Behavioral finance really

  • means--what does it mean? It's not like behavioral

  • psychology. It doesn't mean behavioral

  • psychology applied to finance. It really means something much

  • more broad than that. It means all of the other

  • social sciences applied to finance.

  • The economics department is just one of many departments in

  • the university that teaches us something about how people

  • behave, so if we want to understand how

  • people behave we can't rely only on the economics department.

  • I think that it's coming around to a unifying of our

  • understanding. Since then--since the

  • beginnings in the '90s, our behavioral finance

  • workshops have grown and grown and,

  • of course, so many people are involved in it now;

  • it's now very well-established. Before I get into that,

  • I want to give some additional reflections on the last lecture.

  • I have this chart, which you saw last

  • time--actually it's an Excel spreadsheet that--I also put it

  • up already on the classes V2 website so you can play with it.

  • I just want to reflect again--I know I'm repeating myself a

  • little bit, but it's very important.

  • What we have in this chart is the blue line,

  • which is the Standard & Poor Composite Stock Price

  • Index going back to 1871--from 1871 to 2008,

  • right now--so that's like 130 years of data.

  • That's the blue line. You can see the--do you know

  • what that is there? That's 1929 and that is the

  • Crash of 1929. Well, actually it extended to

  • 1932 and you can see other historic movements.

  • There's the bull market of the 1990s--a very big upswing--and

  • then there's the crash from 2000 to 2003.

  • I don't know if you remember these things,

  • they were big news, not as big as the 1929 crash,

  • but the upswing was just as big as the 1920s upswing,

  • wasn't it? Here's the 1920s upswing and

  • here's the 1990s upswing--huge upswing in stock prices.

  • This is in logs, by the way, so that means that

  • everything--the same vertical distance refers to the same

  • percentage change in the price. Then I had, as I said last

  • period, I have a random walk shown--that's the pink line.

  • The random walk is generated by the random number generator.

  • I fixed the random number generator, so I made it truly

  • normal this time. It slows it down a little bit,

  • but if you press F9 we get another random walk,

  • but it's always the same stock price.

  • This is a random walk with a trend that matches the uptrend

  • of the stock price. I can press--it kind of looks

  • similar, doesn't it? It kind of shows that in some

  • basic sense the stock market and the random walk are the same.

  • Here we have the crash of--here we have the market peak of 1929

  • except it turned out in this simulation to have occurred in

  • 1910 or thereabout. Then we have the--that's The

  • Depression of the '30s except it's not the '30s.

  • I can just push a button and we get something else.

  • I find this amusing. I don't know.

  • Unfortunately, we live through only one of

  • these in our lifetime. There's a TV show about

  • parallel universes, right?

  • What's the name of that show? I can't remember it.

  • Don't you know this show? Where they go in some kind of

  • time machine and they emerge in another parallel universe where

  • history took another course. Well anyway,

  • these are parallel universes that we see.

  • In some of these universes, Jeremy Siegel would write his

  • book, Stocks for the Long Run,

  • and in some of them he would not becausewell,

  • this one he might not because in this case the stock market

  • was just declining for the better part of a century.

  • The thing I don't see in these charts and I think we haven't

  • captured it perfectly with just the standard random walk is I

  • don't see any crash as big as the 1929 crash.

  • It's hard to get them. I keep pushing F9--this just

  • seems to dominate, right?

  • There's nothing as big here--press F9 again--you can

  • keep pushing and pushing, maybe you'll get one but you

  • have--you get the idea that there's something anomalous

  • about that crash from the standpoint of this random walk

  • theory. I'm not getting one, right?

  • That's something that we'll talk about.

  • I would--I'm not--I can push for a long time and I don't

  • see--well there's a pretty big one.

  • Isn't that just about as--not quite as sharp as the 1929

  • crash, but it's hard to get them.

  • I think that one thingthere are a couple

  • of things that we'll come back to.

  • One is--I think I've already mentioned it--fat tales.

  • Stock price movements have a tendency to show some extreme

  • outliers that are not represented by the normal

  • distribution. But also, there are variations

  • in the variance. So, in this period here--in the

  • '20s and '30s--the stock market was extremely variable on a

  • day-to-day basis; it was way beyond anything

  • we've observed since. So, that's why it seems to be

  • more volatile in that period because the accumulation of

  • bigger random shocks. Anyway, we can play this game

  • for a while but now I want to go and talk about--remember that

  • the random walk that we see in stock prices is not the behavior

  • of a drunk, even though you can describe a

  • random walk as drunken behavior. The idea in the theory is that

  • these movements only appear random because they're news and

  • news is always unpredictable. If the market is doing the best

  • job--this is efficient markets--in predicting the

  • future, that means then that any time

  • the stock market moves it's because something surprising

  • happened. Like there might be a new

  • breakthrough in science or there could be war or something

  • outside--this is the story--outside of the economic

  • system that disrupts things. The next question

  • thennow, I've added something--it's on

  • this little tab here--I've added something, which is a plot of

  • present values. This is something that I

  • published in 1981. That's a long time ago,

  • isn't it? It was my first big success.

  • Not everyone liked this article, but what I had--I got

  • into a lot of trouble for it. I learned some people react

  • with hostility when you offend their cherished beliefs,

  • so I was on the outs for a while with this article.

  • I said, it's kind of interesting to think that all

  • these apparently random movements are really resulting

  • in news about something that is fundamental--that's the

  • efficient markets. Every time the stock market

  • moves it's because there was some news about what?

  • Well, it's about present value. The efficient markets theory,

  • in its simplest incarnation, says that the price is the

  • expected present value of future dividends.

  • What I did, in a paper that I published in 1981,

  • is I said, well let's just plot the present value of dividends

  • through time. That's how I constructed this

  • long time series back to 1871; nobody else was looking at it.

  • Typically, researchers want the best data, the high quality

  • data, and so they would look at recent data,

  • which was the best data, and they would think going back

  • to 1871 is crazy because that's so long ago.

  • We have daily or minute-by-minute data by now,

  • but we can't get it for that remote period.

  • On the one hand, as I argued,