Lecture 10 Speculative Bubbles

Question 1

Is the market inefficient?

Answer 1

Yes

Question 2

What is the fundamental principle of optimal forecasting?

Answer 2

Forecasts do not vary more than the forecasted variable

Question 3

What are three behavioral explanations of the volatility puzzle?

Answer 3

• Minsky: financial instability hypothesis
• Barberis, Huang and Santos: house money effect
• Belief in the law of small numbers (hot hand fallacy)

Question 4

Does all this mean that the market is predictable?

Answer 4

Yes, but for longer time horizons. You cannot expect to see solid returns over short time intervals. Market efficiency is a half-truth

Question 5

Why is Talk an important idicator of a bubble?

Answer 5

Since word-of-mouth transmission of the excitement is a hallmark