Efficient Markets: Fictions and Reality

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Eugene Fama, one of the founders of the so-called “Efficient Markets Hypothesis” (EMH), articulated early on the basic narrative that underpins it: “competition… among the many [rational] intelligent participants [would result in an] efficient market at any point in time [in which] the actual price of a security will be a good estimate of its intrinsic value” (Fama, 1965, p. 56).

In the aftermath of the 2007-2009 financial crisis, the “rationality of the market” began to be widely referred to as a “myth.”1 Too many market participants were supposedly “irrational” – that is, they behaved inconsistently with economists’ standard of rationality. But the alternative mathematical “behavioral finance” models that have gained currency since the crisis imply that the “rational market” has not disappeared for good. After all, these models assume that if “irrational” individuals could somehow be barred from influencing market outcomes – by regulatory policy or other means – “rational” participants would re-gain the upper hand, thereby restoring the “rational market.”

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