Tuesday archive: The herd instinct

From 2nd June, 2006:

Every now and then, the markets are gripped by a strange madness. The recent sudden sharp slump in share prices has many commentators recalling October 1987, when the Dow fell by more than a fifth in a day. What is odd about that “Black Monday” is that the collapse was so swift and yet so brief – in retrospect, just a blip in a 20-year bull market.

Small wonder that at such times we can only conclude that animal spirits are at play. What else could explain buying frenzies and desperate crashes? The FT’s own Tony Jackson recently put this received wisdom very clearly: “What we have here is the Greater Fool Theory. This says that even though you are perfectly aware a thing is overvalued… you keep buying it anyway. Why? Because the thing is still going up. When the time comes, you will find a Greater Fool to take it off your hands. Until, of course, the music stops, and the Greater Fool turns out to be you.”

Continued at timharford.com.

Tim Harford’s blog

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Tim, also known as the Undercover Economist, writes about the economics of everyday life.