Haugen attacks the efficient market hypothesis from inside academic finance. He argues that expected stock returns are predictable from a large set of firm characteristics, and that the predictability does not come from bearing risk. His central empirical device is a multifactor expected-return model fitted month by month on dozens of variables covering risk, liquidity, price level, growth potential and past return, then used to rank stocks out of sample.
The findings he emphasizes run against the standard model. Cheap stocks beat expensive ones. Low-volatility stocks earn higher returns than high-volatility stocks, which reverses the central prediction of the capital asset pricing model. Past profitability and recent price momentum carry information about future returns. Haugen reads all of this as evidence that investors extrapolate recent growth too far, overpay for exciting companies, and correct slowly.
The book was written as a short, aggressive teaching text rather than a full research monograph, and it reads that way. It is useful for understanding the empirical case against market efficiency as it stood in the late 1990s, and for the low-volatility anomaly in particular, which Haugen documented long before it became a commercial product.
The work is dated in two ways. Several of the effects he identified have weakened or disappeared since publication, and the profession has since raised the bar on data mining given that hundreds of candidate factors have been published. Defenders of efficiency answer that his factors proxy for risks he did not measure, and that transaction costs eat much of the paper return in small and illiquid names.
Investors who want the empirical case against efficient markets stated bluntly by an academic, especially anyone interested in the origins of low-volatility investing.
Finance professor at the University of California, Irvine and a persistent critic of the efficient market hypothesis; died in 2013.
The New Finance argues that the value premium comes from investors extrapolating past growth rates too far rather than from bearing extra risk, contradicting the risk-based explanation Fama and French offered. The Inefficient Stock Market assembles the cross-sectional evidence, including the low-volatility result that factor products were later built on.
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