For forty years, economist Eugene Fama argued that financial markets were highly efficient in reflecting the underlying value of stocks. His long-time intellectual nemesis, Richard Thaler, a member of the "behaviorist" school of economic thought, contended that markets can veer off course when individuals make stupid decisions.
In May, 116 eminent economists and business executives gathered at the University of Chicago Graduate School of Business for a conference in Mr. Fama's honor. There, Mr. Fama surprised some in the audience. A paper he presented, co-authored with a colleague, made the case that poorly informed investors could theoretically lead the market astray. Stock prices, the paper said, could become "somewhat irrational."
Coming from the 65-year-old Mr. Fama, the intellectual father of the theory known as the "efficient-market hypothesis," it struck some as an unexpected concession. For years, efficient market theories were dominant, but here was a suggestion that the behaviorists' ideas had become mainstream.
"I guess we're all behaviorists now," Mr. Thaler, 59, recalls saying after he heard Mr. Fama's presentation.Well, perhaps not quite. The ECMH is central to both many SEC policy debates and investment techniques. Its validity is thus a critical question. I plan to address the continued validity of the hypothesis in a TCS column (assuming Nick takes it). In the meanwhile, check out these old blog posts: