Behavioral Finance Explains the Stock Market Bubble

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Who isn’t baffled by the continuing run-up in stock prices? Behavioral scientists. They explain that we have a host of biases that make us irrational. Here are the reasons that we have a stock market bubble, presented in two tables.

Bubble Inflators	Behavioral Bias
1 Vaccines will cure the pandemic quickly	Base rate fallacy
2 Earnings will soar in an economic recovery	Gambler's fallacy
3 Federal Reserve will dump $trillions	Hyperbolic discounting
4 Interest rates will remain low	Recency illusion
5 Greed: FOMO is fear of missing out	Dread aversion
6 Investor euphoria: Hopium	Irrational escalation
7 Huge foreign demand	Confirmation bias
8 Millennials believe markets only go up	Continued influence effect
9 FAANG Stock phenomenon	Less-is-better effect
10 Apple &Tesla are each worth a fortune	Neglect of probability
11 The election.	Normalcy bias
12 Belief that amateurs can beat Wall Street	Overconfidence effect
13 Stock buybacks	Outcome bias
14 SPACs: Special Purpose Acquisition Companies	Pro-innovation bias
15 IPOs: Initial Public Offerings	Decoy effect
16 Inflation caused by money printing is ignored	Money illusion

Bias	Type	Description
1 Base rate fallacy	Extension neglect	The tendency to ignore general information and focus on information only pertaining to the specific case, even when the general information is more important
2 Gambler's fallacy	Logical fallacy	The tendency to think that future probabilities are altered by past events, when in reality they are unchanged or actually worse
3 Hyperbolic discounting	Extension neglect	The tendency for people to have a stronger preference for more immediate payoffs relative to later consequences
4 Recency illusion		Favors recent events over historic ones
5 Dread aversion	Prospect theory	Just as losses yield double the emotional impact of gains, dread yields double the emotional impact of savoring
6 Irrational escalation	Logical fallacy	People justify increased investment in a decision, based on the cumulative prior investment, despite new evidence suggesting that the decision was probably wrong.
7 Confirmation bias	Confirmation bias	The tendency to search for, interpret, focus on and remember information in a way that confirms one's preconceptions
8 Continued influence effect	Confirmation bias	The tendency to believe previously learned misinformation even after it has been corrected
9 Less-is-better effect	Extension neglect	The tendency to prefer a smaller set to a larger set judged separately, but not jointly.
10 Neglect of probability	Extension neglect	The tendency to completely disregard probability when making a decision under uncertainty.
11 Normalcy bias	Cognitive dissonance	The refusal to plan for, or react to, a disaster which has never happened before.
12 Overconfidence	Egocentric bias	Excessive confidence in one's own abilities
13 Outcome bias		The tendency to judge a decision by its eventual outcome instead of based on the quality of the decision at the time it was made.
14 Pro-innovation bias		The tendency to have an excessive optimism towards an invention or innovation's usefulness throughout society, while often failing to identify its limitations and weaknesses
15 Decoy effect	Framing effect	Preferences for either option A or B change in favor of option B when option C is presented.
16 Money illusion		The tendency to concentrate on the nominal value (face value) of money rather than its value in terms of purchasing power

Source Wikipedia

Conclusion

Rather than trying to make logical sense out of the bubble, we need to accept that it is not logical. Sometimes the easiest explanations are the best.

Ron Surz is CEO of Target Date Solutions, Age Sage, GlidePath Wealth Management, and co-host of the Baby Boomer Investing Show that you can binge watch on Patreon.

Please watch and support our Baby Boomer Investing Show on Patreon and visit our Baby Boomer Libraries, our Target Date Fund blog, and our GlidePath blog.

For more guidance please see Bursting Bubbles Blast Baby Boomers and How to Minimize the Impact of Inflation, Recessions, and Stock Market Crashes

Behavioral Finance Explains the Stock Market Bubble

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