Bubbles, gullibility, and other challenges foreconomics, psychology, sociology, and informationsciences
School of MathematicsUniversity of MinnesotaMinneapolis, MN 55455, USA
odlyzkoRevised version, August 29, 2010
Gullibility is the principal cause of bubbles. Investors and the gen-eral public get snared by a “beautiful illusion” and throw caution to the wind.Attempts to identify and control bubbles are complicated by the fact that theauthorities who might naturally be expected to take action have often (espe-cially in recent years) been among the most gullible, and were cheerleadersfor the exuberant behavior. Hence what is needed is an objective measure of gullibility.This paper argues that it should be possible to develop such a measure.Examples demonstrate, contrary to the eﬃcient market dogma, that in somemanias, even top business and technology leaders fall prey to collective halluci-nations and become irrational in objective terms. During the Internet bubble,for example large classes of them ﬁrst became unable to comprehend compoundinterest, and then lost even the ability to do simple arithmetic, to the pointof not being able to distinguish 2 from 10. This phenomenon, together withadvances in analysis of social networks and related areas, points to possibleways to develop objective and quantitative tools for measuring gullibility andother aspects of human behavior implicated in bubbles. It cannot be expectedto infallibly detect all destructive bubbles, and may trigger false alarms, butit ought to alert observers to periods where collective investment behavior isbecoming irrational.The proposed gullibility index might help in developing realistic economicmodels. It should also assist in illuminating and guiding decision making.
Current investigations of the great ﬁnancial crash of 2008 concentrate on issues that areancillary, such as banker bonuses and where derivative trading should take place. Strangely(but conveniently for many of those involved) these investigations do not delve into thequestion of whether this crash could have been foreseen and prevented, nor into the funda-mental cause of the crash, namely the extensive gullibility that led to the extreme bubble