Dr. Vernon Smith, a professor of economics at George
Mason University as well as the director of the Interdisciplinary Center for
Economic Science (ICES) at GMU, was named 2002 winner of the Bank of Sweden
Prize in Economic Sciences in Memory of Alfred Nobel-the Nobel Prize in
Economics–for his research in economic bubbles and theories in experimental
economics.
After years of lab experiments and theoretical testing, Smith
discovered that the trading behavior of investors, and how they react to
economic predictions, are what drive stock market prices. "We are talking
about the nature of the market, and people are forecasting the
unforecastable and predicting inherent uncertainty," he says. The prices at
which investors end up buying stocks is usually higher than the price they
said they would accept, he explains. This then drives the price up until no
one is buying anymore, and the bubble bursts. His tests also demonstrated
that markets are more efficient with fewer participants.
We spoke with Smith about his theories and his presentation,
"Understanding Bubbles and Busts," that he will give at the TD Waterhouse
Institutional: Partnership 2003 National Conference, February 5-8 in Los
Angeles.
Why did you choose to cover this topic?
There is nothing new in bubbles and crashes; this is the oldest story in
the markets. Investors were throwing money at online companies in the 1990s,
but many companies were not going to survive. However, that doesn't mean
there is not going to be any long-term value to come out of that.
My favorite example of this phenomenon is the ballpoint pen. When it
first came out it sold for $10 apiece. The ballpoints became more convenient
than the messy fountain pens and ink bottles, so many people invested money
in it. But its price was too high and there wasn't enough demand for it.
People ended up losing a lot of money on it, but a long-term value was
created.
What can we expect from the economy in 2003?
I don't have any reason to expect anything different this year. There is
going to be a long-term value to come out of this phenomenon for the
Internet companies. People weren't converting to online retail fast enough
to support all of the dot-coms. I don't have any doubt that ultimately there
is going to be a solid core of Internet retail businesses, but there are
going to be a lot of people who want to go to stores and look at the goods,
and who enjoy doing that. People who don't have the time are gradually going
to do more [online] retailing. I am not making a forecast, just a prognosis.
Smith's personal web page can be viewed at
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