Markets and firms
Eugene Fama (1939–)
1863 French broker Jules Regnault publishes Playing the Odds and the Philosophy of the Stock Exchange, which states that fluctuations in the stock market cannot be predicted.
1964 US economist Paul Cootner develops Regnault’s ideas on fluctuating markets in his The Random Character of Stock Market Prices.
1980 US economist Richard Thaler publishes the first study of behavioral economics.
2011 Paul Volcker, former chairman of the US Federal Reserve, blames an “unjustified faith in rational expectations and market efficiencies” for the 2008 financial crash.
A commonly held belief among investors is that they can “beat,” or outperform, the stock market. The US economist Eugene Fama disagreed. His study, Efficient Capital Markets (1970), concluded that it is impossible to beat the market consistently. His theory is now known as the efficient market hypothesis.
"In an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value."
Eugene Fama
Fama claimed that all investors have access to the same publicly available information as their rivals, so the prices of stocks fully reflect all the knowledge available. This is the “efficient market.” No one can know what new information will be released, so it should be almost impossible for investors to make a profit without using information unavailable to the competition, or “insider trading,” which is illegal.
However, problems with the hypothesis have been highlighted by behavioral economists. They point to the theory’s failure to account for investor overconfidence and the “herd” instinct. These problems manifested themselves in the Dotcom bubble of the 1990s, where “irrational exuberance” was blamed for artificially inflating technology stock, and the more recent financial crisis of 2007–08.
After these crises many observers have declared the theory redundant; some have even blamed it for the crashes. Eugene Fama himself has conceded that uninformed investors can lead the market astray and result in prices becoming “somewhat irrational.”