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

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"You say to God, 'My beliefs are flawless and I am pure in your sight.'" --Job 11:4

I know of no field of study filled with more methodological errors than the study of how markets work. Someone was bound to see the humor in all the people with big egos winning global honors for ideas that someone new to the subject could point out were obviously wrong. Indeed, many professors have been wearing no clothes for a long time and were proud of it.

I'm impressed that it is a former Fortune editor who appreciated the irony of the story and wrote about it in human terms. That magazine has had a history of jumping on the band wagon of bad economic ideas. Good for Justin Fox.

The ultimate irony of this subject is that in 2059, hundreds of thousands of young business school students will probably still be taught the inaccurate theories that were finally shown to be wrong in the last two decades. I would wager that few people today realize that most of the advocates of the efficient market theory have pulled in their horns in the face of strong evidence to the contrary. Hopefully, this book will help.

It must have been a tough book to write. The key points could have been summarized in a short article. The full story would take many volumes. For the most part, Mr. Fox seems to have kept his story at the right level to show how a small club of economists happily misled those who read their work for a long time based on assumptions that no one would have agreed resembled the real world. The Capital Asset Pricing Model, for instance, had its assumptions revised every few years by academics for a long time in a vain attempt to sustain it. Yet today, I would bet that most Chief Financial Officers of major companies still make decisions based on CAPM (or its near cousins) despite the theory clearly being wrong.

The "prize-winning" economics were writing about the world as they would like to have it: human beings as rational decision-makers where the highly intelligent quickly move out those who aren't. As we have seen, smart people can also outsmart themselves . . . such as by assuming that they have no effect on markets even when they take huge positions that cannot easily be liquidated (Long-Term Capital Management was an example).

The book's main weakness is that it doesn't pay enough attention to the role of company managements relative to financial markets. Also, the silliness of much of the advice for corporations that academics and consultants have peddled for the last 50 years isn't revealed.

My own view (based on many years of unpublished research during the years when no one thought that psychology played any role in markets and wouldn't publish such research) is that the markets are more efficient than is currently believed . . . when you know how to measure them. But the current measurements are hopelessly flawed and I know of no current academic research to correct those measurement errors. It may well be that someone will be able to write an updated version of this book about the silliness of today's ideas about markets in 50 years. I don't doubt that the opportunity to do so will exist