Once burned, twice shy?

Our colleague Vernon Smith argues that new traders are most susceptible to asset market bubbles, largely because of their inexperience. If the market rises again after a bubble bursts, we should take the run up in prices seriously:

Smith points out that market double dips don’t occur in rapid sequence. Indeed, since 1926 the space between down years for the broad market has always been at least two years, and usually much longer, according to Ibbotson Associates data. The closest sequence in the recent past was the two positive years between the 1973-74 bear market and the 7% downturn in 1977.

In other words, Smith argues that the second round of high prices is usually for real. Experience has beaten the traders down into a state of fearfulness, so presumably there is good grounds for their optimism.

I would like to see the more systematic time series evidence, in the meantime here is the article from Forbes.

Here is my favorite part from the article:

To Professor Smith, bubbles perform a great service for capitalism. “Every bubble is driven by great innovations, and they all leave behind a lot of long-term value,” he says.


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