CHAPTER 12Spotting Bubbles Before They Burst: A METHOD FOR IDENTIFYING UNSUSTAINABLE BOOMS
When a person with money meets a person with experience, the person with experience winds up with the money and the person with the money ends up with the experience.
—Harvey MacKay
Although studying booms and busts provides significant fodder for academic discussions and intellectual debates, it is perhaps most useful if it helps us to make money, avoid losses, or, ideally, both. In order to be useful, then, our study of booms and busts must provide tools for proactively understanding if we are investing in an unsustainable boom with the corresponding risks of an imminent bust. As mentioned in the preface, this book does not provide a map of the market. It also does not attempt to provide any insight into market timing. Rather, it provides a probabilistic framework for understanding the likelihood of being in a bubble. The underlying belief of this approach is that, although asset markets may be well behaved and efficient most of the time, they do on occasion stray to extremes. These extremes matter a great deal, and this chapter provides a seismograph to identify the tremors that precede a quake.
Many an academic has made a career out of explaining events from a historical perspective. Few practitioners have had the luxury of living in a world of 20/20 vision comparable to that provided by hindsight. As such, this chapter provides a tool—in the form of a checklist—that individuals and ...