Patterns of Speculation

The collective behavior of economic agents during speculative episodes provides the foundations of this book. Such moments are marked by a special atmosphere of optimism and confidence in the future, which permeates the entire market and society as a whole. Exuberance, ebullience, and bullish are some of the expressions used to describe the up-going phase; whilst words such as uncertainty, fear, contraction and bearish characterize the subsequent down-going phase. Much as Newton’s discovery of universal gravitation could not have derived solely from observing falling apples (despite anecdotal evidence to the contrary), speculative bubbles also require the study of various episodes in order for a comparative perspective to be obtained. The analysis developed in this book follows a few simple but unconventional ideas. Investors are assumed to exhibit the same basic behavior during a speculative episode whether they trade stocks, real estate, or postage stamps. This idea is crucial for setting up a comparative approach. The main objective of this book is to show that behind the bewildering diversity of historical episodes it is possible to find hidden regularities, thus preparing the way for a unified theory of speculation. A theoretical framework is presented in the final chapters, which show how some basic concepts of dynamical system theory, such as the notions of impulse response, reaction times, and frequency analysis, play an instrumental role in describing and predicting various forms of speculative behavior. Much of the text is written at a level that does not require a background in the technical aspects of economics, finance, or mathematics. It will therefore serve as a useful primer for undergraduate and graduate students of econophysics, and indeed for any reader with an interest in economics as seen from the perspective of physics.