The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street: Amazon.co.uk: Justin Fox: Books

Review

"Do we really need yet another book about the financial crisis? Yes, we do - because this one is different ...a must-read." --New York Times

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." --Publisher's Weekly

"Justin Fox's description of how the idea evolved and conquered is fascinating and entertainingly told. Mr Fox has written a worthy successor to "Capital Ideas", the late Peter Bernstein's 1990s classic on the emergence of the rational-market myth: bang up-to-date; alas, without the happy ending." --The Economist

Product Description

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. 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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6 of 6 people found the following review helpful

A brilliant achievement 20 Mar 2010

By MichaelS

Format:Hardcover|Amazon Verified Purchase

Having read a borrowed copy I finally bought my own several months later and was pleased and surprised to receive a second edition. This seems to be the same as the first edition except for the dust jacket and the addition of a two page "Introduction: 2010", which is of some interest but limited substance.
The book is however truly magnificent, with a very broad historical sweep, close discussion with leading players, and massive historial research, all by an author who understands his subject and writes with fine, clear style. The only - minor - downside perhaps is that the discussion of the historical byways can at some points become a bit much for the typical(?) reader to absorb: but the author can be forgiven for wanting to retain such hard won copy.
The book will be of special interest to readers who have some, if only superficial familiarity with at least the the biggest names among the eight page "Cast of Characters" that the author helpfully provides.

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2 of 2 people found the following review helpful

An entertaining history of finance 20 Mar 2011

By P Newall

Format:Hardcover

Don't be fooled by this book's title: it's much more measured and impartial than the name implies.

"The Myth of the Rational Market" strikes a bold claim -- that efficient market theory is wrong and that other interpretations, such as the behavioural critique and complexity theory, can offer better explanations of the stock market. This isn't what Fox believes:

"[The behaviourists] spend their days studying disturbances and biases, but they still trust that Merton Miller's 'pervasive forces' are out there somewhere, pushing prices at least in the general direction of where they belong."

This book is an incredibly entertaining history of finance, starting with Irving Fisher in the early 20th century and going right up to the present day. The title refers to early scholars' overwhelming faith in efficient markets -- which often overstepped the mark of rational analysis of facts to religious dogma.

Since then the behaviourists and other critics have stepped in by listing a number of "anomalies" and ways in which individuals depart from the classical theories. The point is that each time this happens market efficiency is generally improved as arbitrageurs step in to earn profits from them. It's interesting to note that two of the most prominent behaviourists -- Richard Thaler and Andrei Shleifer -- now run large asset management companies on the side which aim to exploit the targets of their academic research.

Wherever the truth lies, most investors will be best off with one strategy: low-cost buy-and-hold investing. If markets are efficient, then minimising costs will maximise your achievable expected returns. If markets are prone to behavioural anomalies, then likely so are you -- in which case you should avoid active speculation. It's fitting, then, that Justin Fox devotes a chapter to the most famous proponent of low-cost investing: Vanguard's John Bogle.

This is a highly impartial and well-written history of finance; covering the pluses and minuses of all the major approaches to the market (Ben Graham's value investing and his later disciples are also mentioned).

5 of 6 people found the following review helpful

Fine study of market madness 16 Mar 2010

By William Podmore

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."

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