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A pity he doesn't understand the theory
on 23 May 2010
The great strength of this book is that it encompasses almost all of the common mistakes in analysing the recent financial fiasco in a reasonably compact and very well written form (and it is for the latter quality it gets 2 instead of 1 stars). And his views on central banks are well argued. But the author has made too many errors in simple finance for this book to be anything other than false and misleading.
The most annoying and fundamental problem is that he assigns to the efficient market hypothesis the belief that the market always gives a fair price for an asset. The efficient market hypothesis actually says that the return from using information is commensurate with its cost - it says, in its most rigid form, that future price moves are not predictable. It says absolutely nothing about whether that price is a true one, or on the other hand whether it is affected by failures in the thinking of the average market punter.
I am not sure where the commonly held belief in market price being a true value comes from. If anywhere, it could be from the theory of the wisdom of crowds - and those who have read Surowiecki's excellent book of that name will know that the prerequisites for that to work (in particular independence of thought and diversity) are generally not present in financial markets. It could be from the use of the market value by accountants looking for an unbiassed and independent (though not necessarily true) price for complex financial assets.
Many groups were at fault in teh crisis, including politicians who were trying to keep the economy growing, City reporters, US homeowners who lied about their income, regional banks who thought they could compete with the big financial institutions, and the practitioners in the big financial institutions (like those Mr Cooper worked in) who sold complexity to those not capable of understanding it. It is so easy for any or all of them to pick up a theory with a name that sounds oxymoronic and use it to blame a few academics for it all. But the target picked was not involved.
A book whose central tenet is based on a fundamental mistake has little value - which is a pity for this is a book where a lot of care and thought has clearly gone in to developing the idea. If you want a proper discussion of the Efficient Market Hypothesis, there was a recent article in the Journal of Applied Corporate Finance by R. Ball (The Global Financial Crisis and the Efficient Market Hypothesis: What Have We Learned?"). Read that - don't go here.