Speculative Prices and Popular Models

T he rational expectations revolution in economics was born of the recognition that the expectations people hold for future economic variables are fundamental to their behavior. Thus, our (economists') economic models require their (those who make up the economy) economic models, models which they use to generate their expectations. The key idea of rational expectations models is to collapse the two models into one: to assume that people know (or behave as if they know) the true model that describes the economy. This idea allows economists to construct simple and elegant models of the economy, models that are appealing theoretically and that can be studied without collecting any data about the models in the minds of economic actors. The problem with the rational expectations models is that collapsing the two kinds of models into one is a gross oversimplification. Obviously, the popular models (the models that are used by the broad masses of economic actors to form their expectations) are not the same as those held by economists. Once one accepts the difference, economic modelling cannot proceed without collecting data on the popular models themselves. This paper reports on such a data collection effort on popular models, using questionnaire survey methods, with the purpose of understanding speculative markets. I will report here on my research to understand the U.S. stock market crash of October 1987; research Fumiko Konya, Yoshiro Tsutsui and I undertook to understand the Japanese stock market crash of October 1987; research Karl Case and I undertook to understand recent real estate booms; and research John Pound and I undertook to understand the periodic "hot" markets for initial public offerings (IPO's) of common stock.