The Myth of the Rational Market

A History of Risk, Reward, and Delusion on Wall Street

By Justin Fox

Published: 28/01/2011
Pages: 400

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.



About the author

Justin Fox

Justin Fox is the business and economics columnist for Time magazine. Previously an editor and writer at Fortune, he appears frequently on CNN and CNBC and has made exactly one appearance on 'The Daily Show' with Jon Stewart. He lives in New York with his wife and son. www.byjustinfox.com

Reviews

“A rich history world’s most seductive investing idea, the efficient markets theory. The jacket copy is right to call this ‘an intellectual whodunit.’ “

– James Pressley, Bloomberg

“They [Myth & Animal Spirits by Shiller] are both important books. Well worth reading.”

– Menzie Chinn, University of Wisconsin and Econbrowser

“Fox argues convincingly … The style here is journalistic, with personal stories that make the book entertaining.”

– Library Journal

“A lucid synthesis of the ideas that went into what Fox calls the rational market.”

– Rob Horning, Popmatters

“What makes Fox’s book so rewarding and so readable is his way with the telling anecdote.”

– Robert J. Hughes, SmartMoney

“[W]hat Fox has put together is a thoughtful, often fascinating, always illuminating history of the idea of market rationality, and the fortunes of the economists, bankers, regulators, philosophers and psychologists who’ve sought to explain the stormy seas of the market (and to get rich while doing it, of course).”

– Cory Doctorow, boingboing

“Fox’s explanations of technical material are superbly accurate and readable … Clearly the result of many years of research and reading, the book is�its epilogue on the ongoing financial crisis notwithstanding�in no sense a rush job. Rather, 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.”

– Cosmo Shalizi, American Scientist

“[T]he 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

“An intellectual tour-de-force … one of the two financial books I have enjoyed most this year.”

– Rational Man, Buttonwood’s notebook, Economist.com

Praise for the US edition:

An “insightful book.” Fox’s “smart journalistic eye and fine prose keep the theoretical discussion lively.”

– Harvard Business Review

A “lucid, lively and learned account.”

– Glenn C. Altschuler, Barron’s

“Fox … spins a fascinating historical narrative. … Fox recognizes that true believers in the market’s efficiency suffered from a ‘blinkered’ mindset and ‘tunnel vision.’ Yet I think he lets them off too easily.”

– Roger Lowenstein, The Washington Post

“An engaging history of what might be called the rise and fall of the efficient market hypothesis.”

– Joe Nocera, The New York Times

“Mr. Fox’s book is really a lively chapter in the history of ideas … Among much else, Mr. Fox presents lucid explanations of Portfolio Theory, the Capital Asset Pricing Model and Option Pricing Theory without the use of a single equation. And he brings the major players in his drama to life with an appealingly breezy style. … With ‘The Myth of the Rational Market’ Mr. Fox has produced a valuable
and highly readable history of risk and reward.”

– Burton G. Malkiel, The Wall Street Journal

“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

An “excellent new history … impressively broad and richly researched.”

– John Authers, Financial Times

“Do we really need yet another book about the financial crisis? Yes, we do – because this one is different …a must-read”

– Paul Krugman, New York Times Book Review

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