The Psy-Fi Blog has a post on Edward Miller’s research into irrational gambling, which gives some insight into bubble psychology. An excerpt:
Edward M. Miller in Do The Ignorant Accumulate the Money has done some research around the effect on the stockmarket of slot machine investors and reckons that there are periods where waves of stupid money can genuinely cause the rough efficiency of the market to break down. He also shows that these effects can’t last forever – if the stupid money is going into unproductive assets the lower return on these will eventually affect prices, especially as sensible money will be going into cheaper, productive ones.
In fact this isn’t too surprising to anyone with a background in social psychology – you don’t need to really understand economics to recognise that waves of irrational behaviour can sweep through groups linked by social ties. One of the oddest forms of behaviour is that a group’s overall opinion on some subject will tend to be more extreme than the average opinion of the group members. This polarisation effect is to do with the instinct towards group conformity and in the markets can lead people into taking more extreme and committed positions on individual stocks and markets than they would have taken on their own.
“Waves of stupid money” is an apt description of commercial real estate investors and lenders at the peak. Similarly, a general partner I know characterized the money he received from some investors as “one eye money”; cash someone whose primary business was not real estate would give him to invest, and which they would keep only one eye on.
Don’t be part of the wave, and keep both eyes on your money.
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