Yesterday, I noted that Paul Krugman wrote that Rational Market theory was still being taught despite the recent lessons that show it has failed.
Fox points out that academic belief in the perfection of financial markets survived the 1987 stock market crash and the bursting of the Internet bubble. Why should the reaction to the latest catastrophe be any different? In fact, what I hear from my finance professor friends is that there’s a lot less soul-searching under way than you might expect. And Wall Street’s appetite for complex strategies that sound clever — and can be sold to credulous investors — survived L.T.C.M.’s debacle; why can’t it survive this crisis, too?
My guess is that the myth of the rational market — a myth that is beautiful, comforting and, above all, lucrative — isn’t going away anytime soon.
Why are humans so susceptible to bad theories and bad choices?
Perhaps it is because that is just the way we are made. This weekend, I listened to a fascinating radio program on how people make choices which shows that we have much less free choice than we think. Otherwise, why would handing someone coffee (either hot or iced) predict our answer 100% of the time to a particular question? How can we protect ourselves from a built-in proclivity to make certain choices? One answer is making it easier to make a better choice (pdf).
Update: John Mauldin has a speech about all the ways Efficient Market Hypothesis fails which you can read at The Big Picture.