In Finance, what is Irrational Exuberance?

Tricia Christensen
Tricia Christensen

Irrational exuberance is a term that many financiers will instantly recognize. These two words used in reference to the dot.com industry by Alan Greenspan during a speech at a 1996 dinner had an immediate worldwide effect on investment in that industry. Since then, the term is associated with the need to carefully watch descriptive language, especially when speaking from a position of authority. On its own, people now use irrational exuberance as a description of investors who overvalue markets, against rational sense, and do so at the risk of losing investments.

Irrational exuberance can describe an investor who overvalues a market.
Irrational exuberance can describe an investor who overvalues a market.

In 1996, Alan Greenspan was the Washington Federal Reserve Board chairman, a position he held from 1987-2006, and his term referred to the tendency for investors to overvalue specific markets, especially the dot.com industry. He and others didn’t realize that such a description, which was buried in the middle of a speech, could have a profound effect. Of course, the speech was broadcasted, making it readily available to people all over the world. This effect was not only due to Greenspan’s description, but the fact that there was accuracy in it, and the dot.com bubble burst occurring a few years later is often thought of as foreseen by Greenspan’s observations.

Alan Greenspan, who was chairman of the U.S. Federal Reserve from 1987 to 2006, was credited with coining the term "irrational exuberance."
Alan Greenspan, who was chairman of the U.S. Federal Reserve from 1987 to 2006, was credited with coining the term "irrational exuberance."

The immediate effect was very noticeable. The day after Greenspan had described investments in this industry as irrational exuberance, stock markets fell by several percentage points all over the world. In London, Tokyo, Hong Kong, Frankfurt, and the US, up to a four percent decline in investing occurred. While markets recovered within a few days, all economists learned how easy it was to influence the market with just a few words. Greenspan was justified in his description, though, as evidenced by the later near-complete collapse of spending on dot.com industries.

Aside from the term being known as an abject lesson in the consequence of speaking to the state of the markets, it’s also known now as descriptive of any investing in a market that isn’t justifiable. Another example of irrational exuberance occurred with investments in the housing market, and the accompanying financial industries supporting them. Investments peaked well above what was rationally justified, leading to profound effects when the market collapsed. Many times when investors speculate without justification they can create bubbles of increased investment that ultimately burst, with severe consequences.

Irrational exuberance is also the name of a 2005 book by Robert J. Shiller, a professor of economics at Yale University. The phrase remains well known as catchwords that evoke a cautionary tale of the effects of expert opinion on investing. Additionally, it remains a description of speculation without rational assessment.

Tricia Christensen
Tricia Christensen

Tricia has a Literature degree from Sonoma State University and has been a frequent wiseGEEK contributor for many years. She is especially passionate about reading and writing, although her other interests include medicine, art, film, history, politics, ethics, and religion. Tricia lives in Northern California and is currently working on her first novel.

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