The "Mathematical Equation" Of Asset Bubbles

Just when you thought the central planners had everything squared away in a tidy little package (the jobless rate is rising? Sell vol. Not enough iPhone 77.25S are being sold? Sell vol. Ben Bernanke’s voice is shaking? Sell more vol. The Russell 2000 is up only 1%? Dump all the vol!), here comes the Harvard-based NBER ( the same people who determine the start and end of recessions), in conjunction with those economic wizards from Princeton, with what is actually an interesting paper discussing the nature of debt (as opposed to equity) bubbles, i.e., “Quiet Bubbles.”

In the paper, the authors postulate the following about credit bubbles (an issue that is obviously quite sensitive in a day and age when central banks are responsible for the gross monetization of some 80-100% of government debt/deficits):

“greater optimism leads to less speculative trading as investors view the debt as safe and having limited upside. Debt bubbles are hence quiet—high price comes with low volume. We find the predicted price-volume relationship of credits over the 2003-2007 credit boom.”

Sadly, the authors completely ignore the fact that there are some several hundred trillion in credit derivatives where the true impact of credit and interest rate bubble manifests itself, because as far as we recall when AIG blew up courtesy of a few trillion in CDS the outcome was far from quiet, not to mention tens of billions of synthetic structured products (or maybe everyone has forgotten the CDO3s 2006?), as well as one particular entity, the Fed, whose DV01 is now so large at $2.75 billion, the Fed not only will never unwind, but even the tiniest rise in rates will force the Fed to monetize even more as the alternative is a toxic spiral that explodes the Fed’s balance sheet. In other words, perfectly logical things than anyone with some practical experience would note but certainly not the Ivory Tower denizens of Harvard and Princeton.

Yet where the paper turns from the merely wrong, to the supremely farcical, is when the authors Harrison Hong and David Sraer, decide to compile a formula that captures and explains the math behind, you know, bubbles – a purely psychological, and utterly irrational, concept, which demonstrates the same hubris best represented by those Marriner Eccles dwelling professors who believe that three programs can correctly predict and forecast the intangible that is the US economy. But hey – at least it has a ton of complex-looking integrals and variances, so it must be correct.

So for anyone who has dreamed of quantifying the irrational human condition, here is the bottom line of the professors’ equation (this jumps straight to the conclusion and ignores the preceding several pages of just as meaningless gibberish):

QED indeed: with central planners like this, is it any wonder why the world, the real world – the one which much to the chagrin of Princeton and the Wachowski brothers, can not be explained by an equation or even inequality, is doomed?

Full “proof” for your LOLing pleasure (and the full paper can be found here):

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