The Origins of Collective Overvaluation: Irrational exuberance emerges from simple, honest and rational individual behavior

Abstract

The generation of value bubbles is an inherently psychological and social process, where information sharing and individual decisions can affect representations of value. Bubbles occur in many domains, from the stock market, to the runway, to the laboratories of science. Here we seek to understand how psychological and social processes lead representations (i.e., expectations) of value to become divorced from the inherent value, using asset bubbles as an example. Using an agent-based model we explore whether a simple switching rule can generate irrational exuberance, and systematically explore how communication between decision makers influences the speed and intensity of overvaluation. We show that rational and simple individual level rules combined with honest information sharing are sufficient to generate the collective overvaluation characteristic of irrational exuberance. Further, our results demonstrate that simple noise in the exchange of value information leads to rapidly increasing expectations about value, even when no one is engaged in exaggerating their expectations for the assets they own.


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