Efficient Market

Mistakes, I’ve made a few

Justin Fox Leave a comment

I just sent off a list of corrections to HarperCollins before the paperback version of Myth goes out for another printing. It's not a very long list: a misplaced apostrophe, a "Buffet" where "Buffett" was intended, and a couple of modest fixes suggested by readers, which I discuss at the end of this post. But this is not the first list of corrections I have sent to my publisher, and it seems long past time that I assembled all the errors in one place.

There were two major waves of typo discovery, one when I got my first copy of the book and discovered a mess of misspellings in the last two pages of the epilogue (which were added after the book had been copy-edited) and another when the copy editor of the English edition read through the book. The substantive errors, on the other hand, came to light in dribs and drabs. Several were pointed out by concerned parties Dick Thaler and Gene Fama; the other corrections all came from careful readers of the book. Here's a rundown:

1. On pages 101 and 102, the original account of the first event-study research, conducted by Fama, Mike Jensen, and Richard Roll, depicted it as mostly Jensen's idea. Fama remembered it differently—and Jensen and Roll said Fama's recollection sounded about right. Here's the new version (Lorie and Fisher were James Lorie and Lawrence Fisher, the driving forces beyond Chicago's Center for Research on Security Prices, or CRSP):

At first Lorie struggled to get scholars interested in using the market data that he and Fisher had collected at CRSP, and asked his Chicago colleagues for help. Fama suggested to Jensen and Roll that they use the database to test how quickly the market reacted to new information. Together with Fisher, the trio examined price movements before and after stock split announcements.

2. On page 186, I wrote that Dick Thaler had been denied tenure at the University of Rochester. That wasn't quite right, Thaler informed me. As it now says in the book, "He tried to leverage a job offer from Cornell University into a promotion to associate professor at Rochester but was turned down."

3. On page 187, I had Thaler as a co-founder of the Society for the Advancement of Behavioral Economics. He was involved with group, but wasn't a co-founder.

4. On page 190, I wrote that when Charlie Plott had asked Gene Fama for advice in the late 1970s in testing the efficient market hypothesis in an efficient market, Fama had replied that his theory "only applies to the U.S. stock market." Fama wrote me to say that, while he didn't remember what exactly he said to Plott, it couldn't have been those words, because he'd already published papers on the efficiency of markets other than the U.S. stock market. Plott figured Fama must be right about that, so we came up with a redo that was somewhat less dependent on purported dialogue from three decades ago:

"He said his theory has nothing to do with experiments," Plott recalled—it applied only to markets in the field. "But aren't the principles of economics general enough to apply to both situations?" Plott remembers wondering. Fama's take, decades later: "Experimental research is no substitute for empirical work on real market data."

5. On page 201 I said the two papers from the behavioral finance session at the 1984 American Finance Association meeting that were subsequently published in the Journal of Finance had both been previously rejected by academic journals. That wasn't true of Thaler and Werner De Bondt's paper on market overreaction (it had never been submitted anywhere), so I deleted that assertion.

6. On p. 319, I mistranscribed a quote from John Maynard Keynes. The corrected quote:

The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.

Some of these errors were fixed in time for subsequent hardcover printings of the book; all were fixed in time for the paperback. But the e-mails from readers keep trickling in.

The most substantial error discovered since the paperback release has to do with Jan Mossin, the Norwegian economist who was one of the several fathers (or at least an uncle) of the Capital Asset Pricing Model. I identified him on page 88 as affiliated with the University of Bergen; in fact, he taught at NHH, which is rendered in English as either the Norwegian School of the Economics or the Norwegian School of Economics and Business Administration. It is near Bergen, but it's separate from the University of Bergen. The next paperback printing will also mention, if there's space, that Mossin got his Ph.D at Carnegie Tech. This seemed relevant given the school's role elsewhere in my book. The definitive online biography of Mossin, in case you're curious, is here.

Also, on page 242, I referred to NYSE specialists and Nasdaq market makers on second reference as "brokers." A reader suggested that wasn't quite right, so I'm changing it to "securities firms."

Got anything else for me?

Benoit Mandelbrot and finance

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Mathematician Benoit Mandelbrot died earlier this week (the news just came out today). I got to know him while editing a piece that he and Nassim Nicholas Taleb wrote for Fortune in 2005, then interviewed him a couple times for Myth of the Rational Market. For a while after that we kept in touch—I remember getting an out-of-the-blue call from him once while riding a crosstown bus through Central Park—but I hadn’t spoken to him in a couple of years. To commemorate his passing, here’s an excerpt from the book dealing with his complicated (and, in light of the recent financial crisis, somewhat tragic) relationship with academic finance.

Mandelbrot was a Polish Jew who had emigrated to France in 1936, spent what would have been his high school years hiding from the Nazis, and then got a doctorate in mathematics at the Sorbonne. It was a 1949 book by Harvard linguist George Zipf that first piqued his interest in strange statistical distributions. Pick a text and rank the words in it by how often each appears, then graph the result, as Zipf did, and you get a fascinating pattern. “The curve does not fall smoothly from most common to least common word,” Mandelbrot observed. “It plunges vertiginously at first, then declines more slowly—like the profile of a ski jumper leaping into space, to land and coast down the gentler slope below.”

Such statistical distributions have become known as “power laws,” because one variable is exponentially related to the other. These patterns, which allow far more room for outliers than the standard bell curve, had first been observed around the turn of the nineteenth century in the distribution of wealth, and it was the statistics of wealth and income that Mandelbrot studied. Then he visited Hendrik Houthakker’s Harvard classroom and saw that cotton futures prices fell into the same pattern as incomes and words. It wasn’t just the ski jump line; the data was also “self-similar”—that is, charts of small snippets looked just like those of large swaths. Mandelbrot was later to find similar patterns in historical climate data along the Nile, the coast of Britain, and the ins and outs of tree bark. After he dubbed them “fractals” in 1982, he was hailed as a visionary, one of the progenitors of the new science of chaos and complexity that was transforming physics and other fields. By then, though, Mandelbrot had long abandoned finance. At the beginning he had been warmly welcomed into the small but growing fellowship of random walkers. Gene Fama became his informal student. Harvard invited him to spend the 1964–65 academic year as a visiting professor of economics. He authored a paper that appeared not long after Samuelson’s in 1965 showing mathematically that a random market would be a rational one.  “The first period was very nice,” Mandelbrot recalled. “They were receptive, but with an ominous cloud.”

The “cloud” was the frustration that developed among economists as they discovered how hard it was to work with Mandelbrot’s power laws. In his depiction of security price movements, variance—the measure of how widely scattered the different data points are—was infinite. For scholars who were just getting acquainted with Markowitz’s depiction of portfolio selection as a tradeoff between mean and variance, infinity was not helpful.

“Mandelbrot, like Prime Minister Churchill before him, promises us not utopia but blood, sweat, toil and tears,” wrote random walk ringleader Paul Cootner in 1964. “If he is right, almost all of our statistical tools are obsolete . . . Surely, before consigning centuries of work to the ash pile, we should like to have some assurance that all our work is truly useless.” Such assurances were not forthcoming, and before long, finance scholars had ceased paying attention to Mandelbrot at all. “The reason people didn’t latch on to that stuff is it’s not that tractable,” said Eugene Fama, who went from Mandelbrot disciple to Mandelbrot ignorer in a few short years in the 1960s. “It’s not that easy to deal with those predictions in a systematic way.”

Physicist M. F. M. Osborne, who visited UC–Berkeley’s Business School in 1972 to teach two finance courses, told his students that Mandelbrot’s ideas about infinite variance were “a stew of red herring and baloney.” Sure, there were jumps and dips in stock prices that couldn’t be shoehorned into a normal distribution, Osborne acknowledged. But for most purposes, it was OK to ignore them. The important thing was to figure out what you were measuring probability for:

You ask what is probable and what is improbable, but definitely not impossible. For rainfall you take 99% of the occasions (days) when you average less than two inches of rain . . . That kind of information is significant for grazing or agriculture, for what kind of vegetation is likely to grow. The improbable situation, which may give much more than 1% of the total rain which may fall, is really concerned with a different caliber of problems. Are the roads going to be washed away, is it safe to build a house in certain locations if you want to live there for twenty or thirty years?

The improbable-but-not-impossible was not something that bell curve statistics could address. But Osborne didn’t see any point in reinventing statistics to handle it. When it came to rare events, he argued, one had to look outside the statistics of randomness and identify actual causes for the anomalies. This required judgment and experience, two areas in which finance scholars possessed no comparative advantage. They focused instead on the probable.

A review of Myth of the Rational Market in The Hindu (and other matters)

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The Indian edition of The Myth of the Rational Market is now out (it's the UK edition, printed on different paper), and last week it was reviewed in The Hindu, one of the country's big English-language newspapers. The review, by D. Murali, is mostly just a summary of the book, but the writer does conclude that it is a "Recommended addition to the professional investors’ shelf."

In other news, Bloomberg's James Pressley included Myth in his list of the top 50 business books published since Jan. 1, 2009, and the Economist.com included it on its roundup of "the best books on the financial crisis and its aftermath."

Also, P.J. Anders Linder of Stockholm's Svenska Dagbladet, whom I remember taking to dinner almost 20 years ago at a sidewalk table at O.T.'s in the lovely (albeit unlaked) Lakeview neighborhood in Birmingham, said something or other in Swedish about the book in his "blogg," and somebody named Elliot wrote a very kind and thoughtful review in his blogg. Or maybe it's just a blog.

Oh, and The New Haven Register covered a speech I gave in New Haven back in April.

Also, the U.S. paperback edition will finally be coming out toward the end of the year. But don't tell anybody. We're trying to keep those hardcover sales going for a while.

A Chinese edition (complex characters) is out!

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ComplexChinese

The first foreign-language edition of The Myth of the Rational Market is in print. From Wealth Press in Taipei. I like the sleeve with all the big headlines (review blurbs and Notable Book citations, I imagine). Other foreign-language editions currently in the works: Japanese, simplified-character (=mainland) Chinese, Korean, French and (Brazilian) Portuguese. Still no Spanish or German or (wat jammer!) Dutch, though.

13 hours, 38 minutes of Myth of the Rational Market fun

Justin Fox Leave a comment

The Myth of the Rational Market is now out as an audiobook! I just bought a copy. It's still downloading (58 minutes remaining) as I write this. I can't imagine I'll ever listen to the whole thing, but I am looking forward to sampling narrator Alan Sklar's rendition. He and I did a lot of talking on the phone over the holidays, as he checked the pronunciations of characters' names with me. The man has a fine voice.

I knew most of pronunciations, but there were a couple that I had never heard said aloud—and discovered, after some asking around, that I had been mispronouncing in my head. Turns out the late University of Chicago economist Melvin Reder's last name is pronounced "Reader" (thanks to Edward Lazear for setting me straight), and rational expectations pioneer John Muth's is pronounced "Myouth" (Bob Lucas came through on that one).

In other news, there are new book-related interviews up at the website of Chai University (a new online MBA provider) and at the Motley Fool's UK site. Plus, I did a commentary for public radio's Marketplace that was informed by my book research.

The UK edition is out!

Justin Fox 1 Comment

The official publication date was Monday, but as it was out of stock at Amazon.co.uk
for the first couple days of the week, it seemed pointless to post
about it. Right now it says there are only four copies left in
stock, so it may be pointless again soon enough. This is not because the book's a big best-seller (it's currently at 8,865 in the Amazon.co.uk ranking).

But I am not going to whine about it. After having lost my first UK publisher because I took so long to finish, I am thrilled that the nice people at Harriman House have seen fit to print the thing. And eventually I'm sure anybody who wants a copy will get one.

Mythukcover

Update: Harriman House is not even remotely to blame for the stocking problems. Amazon.co.uk just runs an insanely lean operation. As best I can tell, they don't like to go into double digits. Right now (Feb. 5) they are again trumpeting that there's "only 1 left in stock." Seriously, Amazon.co.uk, I think I can guarantee sales at least in the dozens. Just order a few more!