We’ve heard a lot lately about R, or the basic reproduction rate of Covid-19. What’s much less appreciated, though, is that economists increasingly believe that R has a close cousin in financial markets.
One clue that this is the case is that the progress of a stock market bubble resembles the spread of a virus. Just as the number of infections seems to rise slowly at first but then explode before falling back, so too do bubbles begin slowly and then accelerate. During the tech bubble, for example, both the Aim index and IT stocks posted their biggest rises just before the bubbles burst – both doubled between September 1999 and February 2000.
There’s also a similar mechanism. Just as a virus is spread by social contact so too are attitudes to shares. Hans Hvide and Per Ostberg have shown that people’s share purchases are strongly influenced by those of their work colleagues. And Tilburg University’s Ben Jacobsen has shown that our asset allocation decisions are swayed by those of our friends and family. In his latest book, Narrative Economics, Yale University’s Robert Shiller shows that it is often word of mouth that draws out attention to shares. The spread of ideas about the economy and stock market, he shows, can be described by the same sort of susceptible-infectious-recovered model that describes the spread of viruses.