Sunday, August 7, 2011

Boombustology: Chapter 3

Asset bubbles are frequently popping up, and back down. They are easy to spot in hindsight, but we appear to lack the tools to recognize them ahead of time. Vikram Mansharamani aims to rectify that with his book, Boombustology. He applies a multi-lens approach to understanding bubbles with the aim of giving the reader the ability to identify bubbles, and thereby avoid being caught unaware.

Generally, economic models assume individuals are perfectly rational. That is to say, they weigh costs and benefits appropriately, and seek to maximize profit with the cold-hearted zeal of a calculating machine.

But recently, a new field called behavioral economics has shown this to be a simplistic view. Humans actually have a number of biases, many of which (discussed through example later in the book) contribute to bubble-forming events.

Mansharamani discusses a number of biases and offers a number of quizzes and puzzles to the reader that illustrate how we fall victim to biases without ever knowing it. Many of the biases fall under the category of heuristics, whereby we seek shortcuts in our brains in order to determine the answers to complex questions.

Among some of the biases illustrated and discussed are overconfidence, anchoring, framing, representativeness and availability. A number of these biases have been summarized a few times in different ways on this site, including here.

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