Myth of the Rational Market on the Daily Show

[I can’t get the embedded Daily Show video that used to be here to work any more; but you can see it here.]

That was nice, huh? I got the call at about 7:30 Wednesday morning that the night’s guest had canceled and they were thinking about having me on as the replacement. Turns out it was Henry Waxman, who was in the hospital (they say he’s feeling better now). By about 10 a.m. it was definite that I was going to be the night’s guest. So I got my Daily Show gig. My line about the babies in high heels, in case you’re wondering, is a reference to this very funny segment.

The Economist reviews Myth of the Rational Market

I was beginning to go through review withdrawal this morning, and it wasn’t pretty. I was cranky, distracted and unproductive. But I knew there was a chance The Economist would be putting up a review in the early afternoon. Sure enough, The Economist did:

Justin Fox’s description of how the idea evolved and conquered is fascinating and entertainingly told. A statement of investor impotence—an attack on the bold ones (“idiots”, said Larry Summers, a distinguished economist) who think they can beat the market—soon became a near-religious belief. Nobel-laureate preachers, such as Milton Friedman and Merton Miller, proclaimed from the pulpits of the University of Chicago that the market could do no wrong.

That’s a bit unfair to Uncle Miltie—who preached not that the market was perfect but that the government was more likely to do wrong than the market was. But not that unfair. At the end is the money quote:

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 review withdrawal is still coming, of course. Soon. And it’s clearly going to be ugly.

Amazon fixation

It is often said that authors check their Amazon rankings "every five seconds." But after a couple of days you learn that you only have to check once an hour, at about ten of. Right now Myth is at #32. But an hour ago this was the status:

No 30 No. 30 is as high as the book has gotten. It may be as high as it ever gets. It's certainly higher than I ever expected it to be. The reason it's #2 in Accounting & Finance and not #1 is that Peter Schiff, author of Crash Proof, was on the Daily Show last night. I wrote a column that probably played a role in getting Schiff that booking, so this is largely my fault. My real fixation, though, is with Martha Stewart's Cupcakes. I briefly overtook it last night, but can't seem to catch it now. What must I do???


Burton Malkiel reviews Myth of the Rational Market for the Wall Street Journal

I knew this review from the author of A Random Walk Down Wall Street was coming, but I didn't know when, and I didn't know how nice it would be:

Mr. Fox's book is really a lively chapter in the history of ideas,
describing the recent evolution of financial thinking as well as the
instruments that such thinking has spawned, such index funds and
derivatives. It is also a history of people — notably the principal
scholars in the field of financial investments, such as Paul Samuelson,
Bill Sharpe, Harry Markowitz and Daniel Kahneman, and the influential
practitioners, such as Jack Bogle, Michael Milken and Alan Greenspan.

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.

Malkiel concludes:

With "The Myth of the Rational Market" Mr. Fox has produced a valuable
and highly readable history of risk and reward. He has not, however,
been able to bury the hypothesis that our securities markets are
usually remarkably efficient.

Well, depends what you mean by "efficient." But I'm not complaining. Definitely not.

I don’t think Eric Falkenstein has read my book

Valiant Defender of the Quants Eric Falkenstein has a very weird post about The Myth of the Rational Market. On Seeking Alpha it's even labeled a "book review," which is even weirder because Falkenstein gives no indication of having read the book. The table of contents, maybe—or I guess it's possible that he read the book but did so in such a state of dudgeon because of the blurb from Nassim Nicholas Taleb on the back cover (Falkenstein can't stand Taleb) that he was unable to digest any of the actual text.

My favorite part of the "review":

There are lots of straw men in this book. Efficient markets does not
imply price changes ('errors'?) are normally distributed. LTCM's
failure, and its positions, were not predicated on the
Black-Scholes-Merton option model's assumptions. No one believes
markets are perfect.

Okay, let's see: I never say in the book that efficient market theory implies that price changes are normally distributed. I do not attribute LTCM's failure to the Black-Scholes-Merton option model's assumptions. I guess I do push the idea in the book that in the 1960s through 1980s a lot of people at the universities of Chicago and Rochester believed that markets were close to perfect but, well, in the 1960s through 1980s a lot of people at the universities of Chicago and Rochester did believe markets were close to perfect. Straw men, eh?

Anyway, all this is a little disappointing, because I'm a big fan of Falkenstein's Falkenblog and at one point considered sending him my two main chapters on risk measurement (that's chapters 8 and 13, for those of you reading at home) for a sort of stress test. (I didn't simply because I ran out of time.)

But it's not that disappointing. Controversy is good for book sales, and a repost of Falkenstein's screed on Henry Blodget's Clusterstock brought a whole pile of entertaining comments, most of them berating Falkenstein. What I would like best, though, is for Falkenstein to actually read the book— and then go on the debating circuit with me.

James Pressley reviews Myth of the Rational Market for Bloomberg

In a very nice review, Bloomberg's James Pressley calls 'Myth':

a rich history of the world’s most seductive investing
idea, the efficient markets theory.

The jacket copy is right to call this “an intellectual
whodunit.” Taken together, the academics and their models
helped precipitate the ugliest financial meltdown since the
Great Depression. Too bad investors didn’t ignore the professors
and follow the lead of Warren Buffett, who made his billions by
beating the “unbeatable” market.

Fox, an economics columnist for Time magazine, shows us
where the bodies are buried among the bell curves as he traces
the rise and fall of a theory that lulled investors into
believing that markets knew best, spread risk and regulated
themselves. The price was always right, until even Alan
said it wasn’t.

He does end on a critical note:

[O]ne wonders why Fox gives such short
shrift to Hyman Minsky’s Financial Instability Hypothesis, which
argues that markets whip up their own internal forces,
triggering waves of first credit expansion and asset inflation
and then credit contraction and asset deflation.

Many investors consider this to be an antidote to what
financial writer George Cooper calls “the efficient market
fallacy.” Yet Fox limits his discussion of Minsky to a brief
brush-off in the epilogue.

Isn’t history meant to be written by the winners?

It's an entirely valid point. And if Pressley is in fact wondering why I shunted Hyman Minsky to the epilogue, it's because I tried really hard to fit him earlier in the narrative and I just couldn't make it work. I imagine that if I been writing (as opposed to just tweaking) after September 2008, I would have tried much harder to fit Minsky in, but it was always going to be difficult because he simply wasn't part of the debate among finance scholars. He still isn't, I imagine—which tells you something about academic finance. Since I'd made the decision to write the book as a series of interlocking narratives, having somebody who wasn't interlocked with the rest of the narrative at all was always gonna be problematic. That said, there has to be some way I could have woven in Minsky and his popularizer Charlie Kindleberger, and Kindleberger's ongoing debate with rational-market true believer Peter Garber. I just never figured out what it was.

But there are lots of paths-not-taken like that when you write a book. I'm still wondering if maybe I made a huge mistake in not giving MIT's Andrew Lo a big role in the narrative. I think this is what I'll discuss in all my TV and radio interviews—my failure to give Hyman Minsky and Andy Lo their due. That kind of stuff totally sells books, right?

John Authers reviews Myth of the Rational Market in the Financial Times

FT columnist John Authers has been writing a lot lately about the problems of efficient market theory. And now he's written a review of my book. A sample:

The theory has now completed its journey from “hypothesis” to “fact”
to “myth”, to borrow from the title of Justin Fox’s excellent new
history of the idea. Fox, a respected US financial journalist, covers
ground that ranges from the notion of market efficiency – that market
prices always incorporate all available knowledge about a security,
with the corollaries that stocks will follow a “random walk” and that
it is impossible to beat the market in the long term – to the panoply
of models for measuring risk and pricing derivatives that came with it.

It is a history going back a century of how the idea came into
being, and of the motivations of the economists who developed it. Fox
makes painfully clear that the men who drew up the theory knew from the
start that its assumptions, such as that stock returns follow a
“normal” or bell-curve distribution, were unrealistic.

Barry Ritholtz delivers the best book blurb yet

In a post about Nocera’s NYT column, superblogger Barry Ritholtz writes:

I am about halfway through The Myth of the Rational Market, and so far, its good wonky fun. (Justin, there’s your pull quote: “good wonky fun).

Barry is a much better man than I. So far I’ve been so obsessed with self-promotion that I haven’t even tried to read his Bailout Nation. But I have looked at some of the charts and stuff (Barry invested a lot of time and money in making the book look good), and they definitely qualify as good, wonky fun.

Experiencing the Joe Nocera effect

My former Fortune colleague Joe Nocera had a nice, long column about efficient market theory in today's New York Times. It gave pretty good play to my book. A sample:

I couldn’t help thinking about Mr. Grantham’s screed as I was
reading Justin Fox’s new book, “The Myth of The Rational Market,” an
engaging history of what might be called the rise and fall of the
efficient market hypothesis.

Mr. Fox is a business columnist for Time
magazine (and a former colleague of mine) who has long been interested
in academic finance. His thesis, essentially, is that the efficient
marketeers were originally on to a good idea. But sealed off in their
academic cocoons — and writing papers in their mathematical jargon —
they developed an internal logic quite divorced from market realities.
It took a new group of young economists, the behavioralists, to nudge
the profession back toward reality.

Mr. Fox argues, echoing Mr.
Grantham, that the efficient market hypothesis played an outsize role
in shaping how the country thought and acted in the last 30-plus years.
But Mr. Fox parts company with him by also arguing that the effect
wasn’t necessarily all bad. As for the question of whether an academic
theory hatched in Chicago led to the financial crisis, suffice it to
say that some questions can never be answered definitively. Which isn’t
to say they shouldn’t be asked.

There's more. And it's a really good column. So check it out.

Anyway, the column went up online last night. I knew it was coming, so I checked the NYT Website every half hour or so until it showed up. I also checked my ranking a couple of times. It was in 5,000-6,000 territory.

This morning we checked Amazon again (my wife and son do most of the checking). The book was on the move. It broke 1,000 around midday. Right now it's at 289—and it's not on sale yet. I'd say Joe writes an influential column.

Picture 1

Roger Lowenstein reviews Myth of the Rational Market in the Washington Post

The review that was meant to run in the June issue of Conde Nast Portfolio—which was shut down after the May issue—has found its way to the Sunday Washington Post (and a Friday evening online posting). The gist:

Fox, a business columnist for Time,
spins a fascinating historical narrative, beginning with economist
Irving Fisher's paean to markets in, alas, 1929. Postwar economists
such as Paul Samuelson
noticed that most investment pros do not beat the averages. This led to
the one positive contribution of the efficient-market hypothesis: Jack Bogle's
invention of index funds, which mimic the performance of the stock
market as a whole and keep ordinary people from wasting their money
trying to beat it.

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. He laments (as if it were necessary) the lack
of any alternative "grand new theory" and finds that the debate has
resulted in a "muddle." Fox concludes, "If you do come up with an idea
for beating the market, you need a model that explains why everybody
else isn't already doing the same thing." Not necessarily. Markets
aren't physics. Maybe no one model explains them.

I have it on reasonably good authority that sometime soon a review will appear in another major newspaper from another very prominent student of the market, and he will say that it's a good book and all but I'm too hard on the true believers in the market's efficiency. Sigh.