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How Media Hype Helps Inflate Bubbles

News accounts can have a significant negative effect on investor behavior in booming markets.

(originally published by Booz & Company)

Propaganda, Public Information, and Prospecting: Explaining the Irrational Exuberance of Central Place Foragers During a Late Nineteenth Century Colorado Silver Rush

Susan M. Glover

Human Ecology (forthcoming)

Date Published: 
August 2009

The tendency for investors to exhibit “irrational exuberance” during mass economic bubbles, from the Dutch tulip craze to the more recent surge in the housing market, is often the result of media hype, according to this paper. The author tested the influence of media by studying a historical example: prospectors’ decisions about where to build mines during the 19th-century silver rush in Gothic, Colo. By comparing the actual location of mines to a model of optimal locations (built by the author using an in-depth analysis of the geography and other factors that would have contributed to the costs of mining silver), she found that media accounts greatly shaped prospectors’ ore-foraging strategies and pushed mining into unprofitable areas. Because it is difficult and expensive for individuals to gather reliable data on the opportunities afforded by a specific situation, they often rely on the media to shape their economic choices. But media may have ulterior motives in reporting business news. In Gothic, the local newspaper was attempting to bring people to the region, drum up new business, and support local investors, and the information it presented was often incorrect. The paper exaggerated ore concentrations and led prospectors to underestimate their risk and investment in time, money, and effort. This study’s conclusions could also describe the recent global financial crisis. Relying on the advice of media and economic advisors, people underestimated the risk of subprime mortgages and, according to the author’s study of foraging behavior, ventured too far from their base position in search of a payoff that never appeared.

Bottom Line:
When decisions depend on information provided by others, especially the media, investors are more likely to make bad choices.

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