The Myth of the Rational Market : A History of Risk, Reward, and Delusion on Wall Street

In this fascinating book, Justin Fox, the business and economics columnist for Time magazine, charts the rise and fall of the myth of the efficient market. This notion was mostly American in origin, so Fox tells its story in a few universities, including, crucially, Chicago. Fox shows how life has exploded the idea that the market can rationally process information and allocates resources efficiently to the optimal use.This is in part a history of those looking for a sure-fire way of making money from the stock market. They share the fantasy that they can know where share prices are going and the level of risk, and that they can produce a `scientific forecast of the market'. Of course, when markets crash, most investing `stars' crash too. If the market were efficient, surely speculators could never beat it?But the crash of capitalism has crashed its theories too. As Alan Greenspan admitted, "the whole intellectual edifice collapsed." Adair Turner, chairman of the Financial Services Authority, said that we had experienced `a fairly complete train wreck of a predominant theory of economics and finance'.Clive Granger and Oskar Morgenstern's 1970 book, Predictability of stock market prices, said, "It is ... a subterfuge going back at least to Adam Smith and David Ricardo to say that market price will always oscillate around the true (equilibrium) price. But since no methods are developed how to separate the oscillations from the basis, this is not an empirically testable assertion and it can be disregarded."Eugene Fama, who had in the 1960s formulated the efficient market hypothesis, admitted in 1991, "Irrational bubbles in stock prices are indistinguishable from rational time-varying expected returns." There was no way to know if the market was irrationally volatile or not. He now believed that prices could go wrong and stay wrong: he no longer believed that prices were right.Markets' behaviour determines the economic reality that market prices are supposed to reflect. The market is created subjectively; it does not reflect the real world. The market is actually not about efficiently allocating capital but about giving speculative parasites chances to make vast profits with our money. As Larry Summers, Clinton's Treasury Secretary, concluded, "We might all be better off without a stock market."

Chronicling the rise and fall of the efficient market theory and the century-long making of the modern financial industry, Justin Fox's The Myth of the Rational Market is as much an intellectual whodunit as a cultural history of the perils and possibilities of risk. The book brings to life the people and ideas that forged modern finance and investing, from the formative days of Wall Street through the Great Depression and into the financial calamity of today. It's a tale that features professors who made and lost fortunes, battled fiercely over ideas, beat the house in blackjack, wrote bestselling books, and played major roles on the world stage. It's also a tale of Wall Street's evolution, the power of the market to generate wealth and wreak havoc, and free market capitalism's war with itself.

The efficient market hypothesis—long part of academic folklore but codified in the 1960s at the University of Chicago—has evolved into a powerful myth. It has been the maker and loser of fortunes, the driver of trillions of dollars, the inspiration for index funds and vast new derivatives markets, and the guidepost for thousands of careers. The theory holds that the market is always right, and that the decisions of millions of rational investors, all acting on information to outsmart one another, always provide the best judge of a stock's value. That myth is crumbling.

Celebrated journalist and columnist Fox introduces a new wave of economists and scholars who no longer teach that investors are rational or that the markets are always right. Many of them now agree with Yale professor Robert Shiller that the efficient markets theory “represents one of the most remarkable errors in the history of economic thought.” Today the theory has given way to counterintuitive hypotheses about human behavior, psychological models of decision making, and the irrationality of the markets. Investors overreact, underreact, and make irrational decisions based on imperfect data. In his landmark treatment of the history of the world's markets, Fox uncovers the new ideas that may come to drive the market in the century ahead.

Chronicling the rise and fall of the efficient market theory and the century-long making of the modern financial industry, Justin Fox's The Myth of the Rational Market is as much an intellectual whodunit as a cultural history of the perils and possibilities of risk. The book brings to life the people and ideas that forged modern finance and investing, from the formative days of Wall Street through the Great Depression and into the financial calamity of today. It's a tale that features professors who made and lost fortunes, battled fiercely over ideas, beat the house in blackjack, wrote best-selling books, and played major roles on the world stage. It's also a tale of Wall Street's evolution, the power of the market to generate wealth and wreak havoc, and free-market capitalism's war with itself. The efficient market hypothesis -- long part of academic folklore but codified in the 1960s at the University of Chicago -- has evolved into a powerful myth. It has been the maker and loser of fortunes, the driver of trillions of dollars, the inspiration for index funds and vast new derivatives markets, and the guidepost for thousands of careers. The theory holds that the market is always right, and that the decisions of millions of rational investors, all acting on information to outsmart one another, always provide the best judge of a stock's value. That myth is crumbling. Celebrated journalist and columnist Fox introduces a new wave of economists and scholars who no longer teach that investors are rational or that the markets are always right. Many of them now agree with Yale professor Robert Shiller that the efficient markets theory "represents one of the most remarkable errors in the history of economic thought." Today the theory has given way to counterintuitive hypotheses about human behavior, psychological models of decision making, and the irrationality of the markets. Investors overreact, underreact, and make irrational decisions based on imperfect data. In his landmark treatment of the history of the world's markets, Fox uncovers the new ideas that may come to drive the market in the century ahead. - Jacket flap. A New York Times Bestseller and Notable Book: “A rich history of the world's most seductive investing idea.” —BloombergA Library Journal Best Business Book of the YearA lively history of ideas, The Myth of the Rational Market by former Time magazine economics columnist Justin Fox describes with insight and wit the rise and fall of the world's most influential investing idea: the efficient markets theory. Longlisted for the Financial Times Business Book of the Year Award, The Myth of the Rational Market carries readers from the earliest days of Wall Street to the global financial crisis and Great Recession, debunking the long-held myth that the stock market is always right in the process while intelligently exploring the replacement theory of behavioral economics.“A fascinating historical narrative, beginning with economist Irving Fisher's paean to markets in, alas, 1929.” —Roger Lowenstein, The Washington Post“Brilliantly tells the story of how [the finance industry's] edifice was built—and why so few were willing to acknowledge that it was a house built on sand.” —Paul Krugman, The New York Times Book Review“His analysis is singularly compelling and the rare business history that reads like a thriller... A must-read for anyone interested in the markets, our economy or government.” —Publishers Weekly (starred review)“A valuable and highly readable history of risk and reward.” —Burton Malkiel, The Wall Street Journal Introduction : It had been working so exceptionally well Early days. Irving Fisher loses his briefcase, and then his fortune A random walk from Fred Macaulay to Holbrook Working The rise of the rational market. Harry Markowitz brings statistical man to the stock market A random walk from Paul Samuelson to Paul Samuelson Modigliani and Miller arrive at a simplifying assumption Gene Fama makes the best proposition in economics The conquest of Wall Street. Jack Bogle takes on the performance cult (and wins) Fischer Black chooses to focus on the probable Michael Jensen gets corporations to obey the market The challenge. Dick Thaler gives economic man a personality Bob Shiller points out the most remarkable error Beating the market with Warren Buffett and Ed Thorp Alan Greenspan stops a random plunge down Wall Street The fall. Andrei Shleifer moves beyond rabbi economics Mike Jensen changes his mind about the corporation Gene Fama and Dick Thaler knock each other out Epilogue : The anatomy of a financial crisis “Do we really need yet another book about the financial crisis? Yes, we do—because this one is different....A must-read for anyone who wants to understand the mess we’re in.” —Paul Krugman, New York Times Book Review “Fox makes business history thrilling.” — St. Louis Post-Dispatch A lively history of ideas, The Myth of the Rational Market by former Time Magazine economics columnist Justin Fox, describes with insight and wit the rise and fall of the world’s most influential investing idea: the efficient markets theory. Both a New York Times bestseller and Notable Book of the Year—longlisted for the Financial Times Business Book of the Year Award and named one of Library Journal Best Business Books of the Year— The Myth of the Rational Market carries readers from the earliest days of Wall Street to the current financial crisis, debunking the long-held myth that the stock market is always right in the process while intelligently exploring the replacement theory of behavioral economics. Examines the rise and fall of the efficient markets theory, the development of modern finance, and the rise of behavioral economics, in an account that draws on interviews with top thinkers while demystifying the ideas that forged the modern market.