Book Review - The Myth Of The Rational Market

Do you want a solid summary of economic and financial theory concerning the stock market over the past century? Justin Fox's The Myth Of The Rational Market may be the book for you. Above all else, the book seems focused on showing how the notion of an efficient market has been decimated or at least significantly redefined over decades of real-life experience and reflection.

In The Myth Of The Rational Market, Fox starts more or less at the beginning, with the first serious economists to attempt to build models and theories about the market. He then goes through the major theorists, theories, and events in a more or less sequential process. Along the way, he pays extra attention to the ill-fated attempts of those who have tried to build predictive models and implement them on a large scale with other people's money.

One of the things I appreciate about Fox's approach is that he does not go out of his way to denigrate or embarrass those whose theories have since been discredited. Among the points he repeats on more than one occasion is what, exactly, a model is supposed to be. This is a worthy subject, because I think too many analysts, commentators, and writers commit some glaring mistakes when evaluating theoretical models. Models are, by definition, supposed to be a simplification of a complex system. So, for commentators to criticize models for their simplistic assumptions (and this is a very common occurrence) is to largely miss the point.

I also appreciate that he gives a fair bit of respect to those who *have* managed to sustainably make money from the markets. He does not merely fall back on the "in any large group, somebody will get lucky" excuse, but rather observes that there tend to be strong, deep fundamental value approaches underlying the proven long-term approach (even Soros is a value guy to some extent when you look at how he makes his biggest bets).

I know that reviews are supposed to bring up the flaws of a piece, but there are not too many here that really stand out in my immediate memory. If you are only interested in "how to invest" types of books, this book will be of almost no use to you (though it could offer up a handy lesson in how prior "sure-thing" theories ultimately flopped). Consequently, this is pretty much just a book for those interested in the history and evolution of financial theory and the process that goes along with it.

One other potential criticism is the importance that Fox assigns to the efficient market hypothesis. In some cases, he pushes the case that widespread acceptance of the efficient market theory is what has set us up for the myriad crashes and panics we have seen over the years. By the same token, he also goes to some lengths to talk about how the hypothesis has been increasingly ignored and discredited in recent decades and is no longer the driving force of active managers (though it still does inform, and undermine, some of their modeling and performance metrics). So, in some respects he does seem to refute or undermine his own arguments at times.

Ultimately, the biggest take-away point of the book is that elaborate models are never dependable and those who attempt to build their fortunes on those models and theories are almost doomed to fail. Going a step further, the more intricate the model and the larger the sums invested behind it, the bigger the expected failure. Perhaps that is not a major revelation, but it leads to a sound pithy takeaway - keep it simple and look for real value lurking within real companies.