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The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street Hardcover – Jun 9 2009

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Product Details

  • Hardcover: 400 pages
  • Publisher: HarperBusiness (June 9 2009)
  • Language: English
  • ISBN-10: 0060598999
  • ISBN-13: 978-0060598990
  • Product Dimensions: 15.2 x 3.2 x 22.9 cm
  • Shipping Weight: 544 g
  • Average Customer Review: 5.0 out of 5 stars 1 customer review
  • Amazon Bestsellers Rank: #274,477 in Books (See Top 100 in Books)
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Product Description


“Do we really need yet another book about the financial crisis? Yes, we do — because this one is different. Fox’s book is not an idle exercise in intellectual history, which makes it a must-read for anyone who wants to understand the mess we’re in.” (Paul Krugman, New York Times Book Review)

“Justin Fox is a truly insightful fellow who can see things with his own eyes—a rare, very rare attribute.” (Nassim Nicholas Taleb, author of The Black Swan)

“A fascinating historical narrative.” (Roger Lowenstein, The Washington Post)

“This wise and witty book is must reading for anyone who wonders what makes financial markets tick. Even those who have wrestled with this question for years will be glad to have read Fox’s compelling history.” (Peter Bernstein, author of Against the Gods: The Remarkable Story of Risk)

“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, this dense but spellbinding work brings modern finance and economics to life.” (Publishers Weekly (starred review))

“A lucid, lively and learned account.” (Barron's)

“Fox makes business history thrilling.” (St. Louis Post-Dispatch)

“Impressively broad and richly researched.” (Financial Times)

“...a rich history of the world’s most seductive investing idea...the book chronicles the rise of rational market theory over the decades and captures the sizzle and pop of the intellectual debate ...” (Bloomberg)

“Good wonky fun.” (Barry Ritholz, The Big Picture blog)

“An intellectual tour-de-force...” (The Economist)

“Superbly accurate and readable... Clearly the result of many years of research and reading,... it is a model of what the popularization of social science can be, but too rarely is, and it will continue to be read when the current crisis is many years behind us.” (American Scientist)

“A tough, tasty steak of a book.” (Dan Neil, Los Angeles Times)

“A thoughtful, often fascinating, always illuminating history of the idea of market rationality.” (Cory Doctorow, boingboing.net)

From the Back Cover

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.

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Top Customer Reviews

Format: Hardcover
"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.
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Most Helpful Customer Reviews on Amazon.com (beta)

Amazon.com: HASH(0xa089efc0) out of 5 stars 109 reviews
132 of 139 people found the following review helpful
HASH(0xa079a39c) out of 5 stars Don't believe the title, but read the book July 16 2009
By Herbert Gintis - Published on Amazon.com
Format: Hardcover Verified Purchase
A few years ago business and economics journalist Justin Fox went to the University of Chicago to talk to Efficient Markets guru Eugene Fama and behavioral economist Richard Thaler. He then went back to New York and wrote an article entitled "Is the Market Rational?" The headline for the article read "No, say the experts. But neither are you---so don't go thinking you can outsmart it." Out of this encounter came this pretty mammoth, extremely informative, and lively written narrative of modern financial economics. If you read this book and take its arguments seriously, you can avoid the major pitfalls that doom some investors to penury. On the other hand, if you think you can beat the market through personal testosterone and shrewdness, don't bother buying the book. Save your money. You'll be on the bread line soon enough.

Saying that people are irrational and the market is irrational is of course now all the rage. But, if you think you can romp your way to financial security by taming your animal spirits and feeding off the market's irrationality, I assure you, and Justin Fox assures you, that such is not the case. "While behaviorists and other critics have poked a lot of holes in the edifice of rational market finance, they haven't been willing to abandon that edifice." (p. 301). The reason is that the edifice is usually correct, although it can experience spectacular failures. The problem is that we don't know when it will experience these failures. We do know, or at least I strongly believe, that the failures are due to herd behavior of investors, which undermines the applicability of the normal statistical distribution, the mainstay of traditional financial theory.

The theory that financial markets are rational is called the Efficient Markets theory. It has two parts. The first is that unless the investor has some inside information not available to other investors, he cannot tell if stock prices are too low, too high, or just right. This means that on average you can't gain by using a general theory that says when stocks are over- or under-valued. The evidence in favor of this theory is overwhelming. If your stockbroker tells you he can pick winners, run as fast as you can. Indeed, the best policy is simply to invest in low-overhead mutual funds, and look VERY closely at the overhead. You'll do very well that way over the long haul. Trust me.

The second half of the efficient markets theory is that market imbalances cannot persist for more than a very short time, because as soon as they are discovered, they will be arbitraged away. There is fairly good evidence that this half of the theory is often wrong; the stock market, for instance, can suffer run-ups for long periods of time; everyone knows the market is out of balance, but no-one knows when to get off the gravy train. Moreover, a financial manager that fails when all others fail (e.g., after a melt-down) will not be blamed, but one who gets off the train too soon will be widely vilified and discredited. I recall that some economists were predicting a financial crisis a full three years before it actually occurred. This is okay for on-lookers, but real players cannot get off the train too soon. Whence the failure of the second half of efficient markets theory.

This book is an extremely valuable resource for the non-professional. There are no equations, but Fox gives one a pretty good idea of what assumptions lie behind a theory, and what arguments and data can be erected for and against it. Financial economics is about the most difficult area of economics because it uses very high-powered math, including stochastic differential equations. The huge amount of financial data makes it relatively easy to test financial theories, so we know fairly well what works and what doesn't. Fox does a totally convincing job of being balanced without ever being boring or simply taking the middle-road. The book deserves it widespread popularity.
105 of 111 people found the following review helpful
HASH(0xa079ca68) out of 5 stars Too Short June 24 2009
By Samuel J. Sharp - Published on Amazon.com
Format: Hardcover Verified Purchase
Overall, Fox has written a very good book which covers a remarkable amount of material in only 322 pages. The problem is that this book, if properly done, should run around 600+ pages. Granted, Fox is a journalist, not an academic, so his audience might not have an appetite for a book that takes a month to read, but the topic is interesting and important enough to warrant a more detailed discussion.

Fox's book is organized primarily by ideas and then chronologically. This can lead to jarring jumps between time periods within chapters and the reader suspects that important topics are being missed. The twelve-page epilogue for example begins in 1833 and is in the 1960's by the turn of the page.

The mathematics discussed in the book is not terribly complicated but the reader is given no formulas, no graphs, no applications of the quantitative theories. Yes, everyone knows what normal distribution looks like but the power laws discussed deserve a chart. Mandelbrot's fractal theories need a diagram. Fox would also support his argument more strongly if he included the formulas which were eventually altered by the behavioralists. Without these, the reader is forced to blindly trust what Fox is telling him.

Despite these minor criticisms, the book is definitely worth reading. I am guessing that the title attracts many readers who hope financial-economics moves beyond the Chicago School efficient-markets framework. If this is what readers want, I recommend Beinhocker's "The Origin of Wealth." If you want a quick tour of academic financial thought, read Fox.
58 of 61 people found the following review helpful
HASH(0xa079ca2c) out of 5 stars Only okay for me. Nov. 27 2009
By A. Kennedy - Published on Amazon.com
Format: Hardcover Verified Purchase
I was intrigued when my Finance professor assigned The Myth of the Rational Market (TMRM) to our class as a supplement to the textbook. I'm something of a history buff and thought it might make for interesting reading. I was disappointed. The book has a bit of an identity crisis. It's likely a little too light for serious students of the subject, yet a little too technical for entertaining reading. Just as I would get familiar with (and interested in) a subject, Fox would move on to a new person. It became a little frustrating and I don't think I could recommend it to the casual reader. TMRM became the book I made myself read at least a little of each week, and that is unusual.

This isn't to say there weren't entertaining and educational parts. Justin Fox does a nice job in bringing the complex topics of efficient market theory, option-pricing models and CAPMs down to a layman's level. His research is impeccable and he highlights all the major players; Black, Fisher, Friedman, Keynes, Modigliani and Buffett, as well as a large cast of supporting players. Fox does a much better job, in my opinion however, with more "modern" economic figures than with the "founding fathers". His discussion of Mac McQuown's work at Wells Fargo to develop index-based mutual funds helped shed light for me on modern banking methods, and I now understand Michael Milken and the concept of junk bonds much better than before.

In both the "Early Days" section and the "Rise of the Rational Market" section, I felt like I was trying to drink from Niagara Falls with the deluge of names, places and theories. Without some kind of a personal reference to dates and eras, I felt all of the information simply washed over me. It wasn't until Fox began his "Conquest of Wall Street" section and through the end of the book, that I became truly interested in the subject matter again. I was able to connect the development of risk controls, hostile takeovers, stock options and the study of human nature to my own observations. My favorite chapters were probably those on Warren Buffett and Alan Greenspan. Fox seems to really dig into the subject of both men with a little more interest than many of the previous. I was able to satisfy my desire for details on each without feeling overwhelmed.

The Epilogue (The Anatomy of a Financial Crisis) was likely the most useful and interesting part of the entire book in my opinion. At last, this was the chapter I had hoped the entire book would be. It was simple, entertaining and educational. I finally understood a lot of what has gone on in the world of Fannie Maes and Freddie Macs. Subprime mortgages and Ponzi schemes became much clearer. I only wish the entire book had been written at this level. In the end, there is no clean wrap-up from Fox, but none should be expected. The financial market is an ongoing subject.

All in all, The Myth of the Rational Market is a decent overview on the subjects of the efficient market theory and Wall Street. It offers no answers and is difficult to slog through at times. If you can make it through the first half of the book, you will likely enjoy the second half much more. And you will find yourself educated, even if somewhat overwhelmed.
109 of 121 people found the following review helpful
HASH(0xa079cd20) out of 5 stars COMPREHENSIVE, COMPLETE AND CLEVER June 9 2009
By Sanford - Published on Amazon.com
Format: Hardcover
Justin Fox has a great blog and writes for Time magazine, having previously written for Fortune magazine. So it was not a surprise that his book is well written and fast paced. Better yet, he has chosen to cover the most critical topic in all of finance: does the market correctly price stocks, bonds and real estates? In delivering a masterpiece he has either killed himself in thoroughly researching the subject or someone talented has directed him to all the right issues. He correctly dates the emergence of the efficient markets theory to the early twentieth century, then covers the contribution of Paul Samuelson, who is oddly enough always forgotten in any coverage about the efficient markets doctrine. He then goes through the sequence of Markowitz, Miller, Modigliani, Fama and Michael Jensen (an odd insertion indeed, since Jensen sweared by efficient markets theories but made his name emphasizing firm level inefficiencies, ones profitably eliminated by buyout funds, but whose profits would not be so impressive if the market could correctly price their coming contribution). He then introduces Richard Thaler and Robert Shiller, and thus downplays Amos Twersky and Daniel Kahneman, which is a failing of the book.

All in all it is a competent masterful history of financial theory and is a must buy for anyone with interest in investing. What it does not pretend to do is give readers a better idea of how to tackle market decisions. That is fine. What is not fine though, and what should be fixed in any future edition, is the lack of hard evidence on why markets are inefficient. There has to be a chapter on Warren Buffet and Peter Lynch and George Soros too, who made mince meat of efficient markets theories with the money they made. The point cannot be made from quotations of famous people alone. Had Justin Fox done that, he would have created a more complete book, what could even have been a classic. Also missing is the destruction derivatives have caused, and which are the offshoot of efficiency dogma. Once again Justin Fox tries to get off by a quotation here or there, but it is insufficient.
26 of 28 people found the following review helpful
HASH(0xa07aa234) out of 5 stars An excellent popular history of people and ideas June 28 2009
By Aaron C. Brown - Published on Amazon.com
Format: Hardcover
Fox covers a century of academic research and market events with remarkable comprehensiveness. He gets both the people and the ideas right, few popular accounts get even one out of two. Everyone, including me, will have some quibbles, a few people who did not get enough respect and some who got too much, some minor technical differences, but the book is absolutely fair. Perhaps most remarkably, it's fun to read.

Financial professionals should read this book to fill in gaps they may have in their knowledge of the history of the field, or to get a quick summary of theoretical changes since they left school. Serious non-professionals should make this their first choice for a general understanding of the field, before earlier classics like A Random Walk Down Wall Street, Irrational Exuberance, Stocks for the Long Run and Against the Gods. Those are all great books, but this one is better because it's comprehensive. The only competition should be John Bogle's Common Sense Investing which will give you more immediately practical advice, but a lot less history and theory.

One point previous reviewers either left out or disagree with is the title is misleading. This is not a book arguing that theories based on rational markets are wrong or bad. It describes how rational theories were built on solid theory and evidence, but grew into a myth both more extreme and more certain than was justified. They did a lot of good by displacing damaging inferior ideas, but also pushed aside a few important truths. Theory began to affect the market more than the market affected theory. After a period of reappraisal, rational markets are still vitally important, but theorists and practitioners have more nuanced and balanced understandings of their limitations.