Learning about bubbles by living through them

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Alex Tabarrok offers a handy summing-up of what experimental economics has taught us about bubbles:

In the lab we can create artificial assets with known dividend streams and thus known fundamental values. Since Vernon Smith’s classic experiments (JSTOR), we know that even in these cases efficient markets fail and bubbles are common.  …  Circuit breakers and brokerage fees (transaction taxes), for example, don’t do much to stop bubbles (see King, Smith, Williams, and Van Boening 1993, not online.) Investor education doesn’t help (for example telling participants about previous bubbles doesn’t help). Even increasing interest rates doesn’t do much to stop a bubble already in progress and may increase volatility on net.

Futures markets (JSTOR) and short selling do tend to dampen but not eliminate bubbles, thus, there is a case for expanding futures markets in housing and making short selling easier (not harder!).

Bubbles are also less common with more experienced traders – this is one of the strongest findings.  Don’t get too excited about this, however, it’s experience with bubbles that counts not just trading experience.

Now, as Tabarrok points out, we’ve all got lots of experience with bubbles. Yay for us.

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