Many practitioners in financial markets and nearly all academics live in a constant state of denial. They believe markets are efficient. This creed is the cornerstone of Modern Portfolio Theory, CAPM and the Black-Scholes options pricing model. Yet, the idea that participants in markets act rationally with regard to returns and risk and that therefore assets are priced correctly and prices are constantly adjusting to new information is plainly, empirically, wrong. The 1987 crash, the dotcom boom and bust, the manifest mispricing of credit (in part a by-product of the biggest bubble in house prices ever seen) are just four examples from recent times of inefficient markets.
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