Red-Blooded Risk: The Secret History of Wall Street

Efficient Markets

There is a persistent myth about efficient markets theory. It holds that ivory-tower academics invented it because it fit their simple concept of the world, and from time immemorial these academics have enforced it as an orthodoxy on practitioners who knew better and students who did not. The truth is different. Until the 1950s, almost no one believed in efficient markets, on campus or off. It was taken as obvious that professional investors knew much more than average investors, and both knew much more than monkeys throwing darts at the stock quotation page of a newspaper (younger readers can substitute monkeys pushing random keys at finance.Yahoo.com).

But then some professors and graduate students started checking. A few maverick practitioners had done this earlier, but without attracting much attention. The evidence started as a trickle but turned into a flood. Professional investors did no better than random selections, before tacking on their fees and running up expenses. They even seemed to do a bit worse, because they all bought the same things, forcing up the prices, and they all sold at the same time. Although each year some professionals did beat the market, the ones who did were no more likely than anyone else to beat the market the next year. And investors did worse than the reported fund results, because on average they got in when the market was high and out when the market was low. Published theories of how to invest stood up no better. Once you ...