Colin Camerer

Colin Camerer is an economist whose role in the book centers on designing a Caltech trading experiment that made the mechanics of a bubble unusually visible. Its shares had a precisely calculable value, yet students traded them at prices far above that value; when Camerer asked why, their answers exposed the expectation that someone else would take the loss. The experiment makes Camerer an interpreter of the gap between knowing an asset’s worth and believing one can profit from other people’s behavior.

The Caltech experiment

At the Experimental Economics Laboratory at Caltech, students traded shares in an imaginary company over fifteen five-minute periods. Each share paid a dividend of 24 cents at the end of every period. A share held throughout the experiment therefore paid $3.60 in total, setting a clear upper limit on what a rational buyer should pay before trading began. As each period passed, the remaining dividends—and thus the share’s value—fell by 24 cents.

The design left little room to blame a bubble on uncertainty about the asset itself. Unlike a real stock, the shares had a known payoff schedule, and participants knew when the experiment would end. They began with two shares each and money with which to buy more. Their only channel of communication was their buy and sell orders; they were not talking to one another or egging one another on.

Nonetheless, prices rose immediately to $3.50 and stayed near that level almost until the experiment was over. The market continued to trade shares at $3.50 when their dividend value had fallen below $3, then below $2, and even below $1. Students paid more for shares than the remaining dividends could return, despite having the information needed to see that they were overpaying.

Camerer’s explanation of the buyers

Camerer asked students why they had bought at prices they knew were irrationally high. Their answers, as reported in the book, were that they knew the price was excessive but saw others trading at high prices and expected to buy, collect a dividend or two, and sell at the same price to someone else. The bet was not that the share’s underlying value would recover. It was that another buyer would arrive before the opportunity to resell ran out.

That explanation gives the experiment its central reversal: participants could recognize the discrepancy between price and value and still choose to trade. Their calculation incorporated the behavior they observed in other traders, but that dependence did not make the group wiser. Each participant’s hope of reselling relied on the next person sharing the same hope, while no new information about the company’s dividends could justify the price. The familiar expectation that a greater fool would appear thus became a mechanism sustaining the bubble.

What the experiment reveals—and what it cannot

The experiment isolates a danger in dependent decision-making. Even with the payoff known, the trading period limited, and communication restricted to orders, a bubble formed. The result suggests that market participants can collectively sustain inflated prices without being misled about the basic facts or openly persuading one another. The belief that a resale will remain possible can matter more to a buyer than the asset’s calculable return.

The book also marks the limits of what Camerer’s experiment can establish about real financial bubbles. His students could openly describe their strategy as seeking a greater fool; people caught up in an actual bubble may instead come to believe that rising prices are justified. Buyers of Cisco shares when the stock was the world’s most expensive, for instance, may have believed that its price would keep increasing, with that optimism containing the belief that Cisco could truly be worth $500 billion. The experimental traders’ candid awareness of overpricing therefore clarifies one possible mechanism, but does not account for every belief that can accompany a real boom.

Nor does the experiment make every instance of following others irrational. Drawing on the book’s earlier discussion of imitation and information cascades, the argument recognizes that relying on others can be useful: a market price may be right when it incorporates dispersed judgment. The danger appears when everyone relies on the group’s apparent wisdom and nobody contributes an independent judgment that could make it wiser. Camerer’s experiment supplies a stark case of that dependence: the price keeps its authority even as the dividends fall away, because traders expect to pass the share along rather than ground its price in its remaining value.