When Will the Next Bubble Burst?
The study: "Bubbles, Gullibility, and Other Challenges for Economics, Psychology, Sociology, and Information Sciences," by Andrew Odlyzko, the School of Mathematics at the University of Minnesota, published on FirstMonday.org.
The thesis: Even the most savvy business leaders succumb to speculative frenzy. But warning signs are sometimes present. Therefore, building a "gullibility index" could help investors and policymakers identify irrational behavior.
The method: Odlyzko analyzes financial bubbles, including the most recent real estate frenzy and the resulting financial crisis. He gives tech bubbles especially close scrutiny, quantifying, for example, the extent to which telecom companies in the late 1990s overestimated demand for Internet capacity.
Intriguing point: Bubbles have a positive side: They foster excitement and contribute to progress. For example, many of the survivors of the dot-com bust, such as Google, Amazon, and eBay, are today's Web traffic and e-commerce leaders.
The takeaway: A gullibility index can be constructed by quantifying indicators such as investor expectations of annual returns of 20 percent or higher. Odlyzko plans to use social networking sites as he works to establish a gullibility index within the next few years.
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