The Myth of the Rational Market

Justin Fox, a business journalist, wrote an intellectual history of the efficient markets hypothesis: where the idea came from, how it came to dominate academic finance and then investment practice, and how it was challenged.

The narrative runs from Irving Fisher and Alfred Cowles through Bachelier's rediscovered thesis, the Cowles Commission's statistical work, Markowitz and portfolio theory, Modigliani and Miller on capital structure, Sharpe and the capital asset pricing model, Fama's synthesis of the efficient markets literature, and the practical consequences including index funds, option pricing and the derivatives industry. Fox is good at showing how each theoretical step depended on assumptions adopted for tractability that later hardened into claims about the world.

The second half covers the challenges: Shiller's volatility tests, Thaler and the behavioural programme, Kahneman and Tversky's psychology, Grossman and Stiglitz's demonstration that perfectly efficient markets cannot exist because nobody would have an incentive to gather information, and the practical failures including Long-Term Capital Management and the 2008 crisis. Fox's conclusion is that the hypothesis was useful as a benchmark and damaging as a belief, particularly in its influence on risk management and on regulation. The book is journalism rather than technical exposition and simplifies in places, but it is the best available account of how a set of academic ideas came to shape an industry.