Order The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street

The first 95% of this book represents one of the best summaries of leading intellectual thought concerning the efficiency (or rationality) of financial markets. My guess is that if you have an interest in the concept of market efficiency, you will enjoy this well-researched summary. Author Justin Fox covers a lot of ground and does a good job at it. However, it's my opinion that for some lay readers, this isn't going to seem like a page-turner.

The list of economists, statisticians, investors, etc. covered in this book reads like a who's who of the important figures in the history of investment theory. Importantly, the reader gets to see the intellectual connections (and in some cases the interpersonal connections) between the likes of Louis Bachelier, Henri Poincare, Irving Fisher, Roger Babson, John Maynard Keynes, John Burr Williams, Alfred Cowles, Paul Samuelson, Harry Markowitz, Franco Modiglianni, Merton Miller, Gene Fama, Michael Jensen, Richard Thaler, Robert Schiller, Ed Thorpe and others well known in the field of financial market theory.

While "modern" portfolio theory (MPT), which dates back to the 1950s and 60s, became increasingly accepted through perhaps the late 1970s (thanks in good part to the pioneering efforts of some of the economists mentioned above), in more recent times behavioral finance--which looks more at what people actually do, as opposed to what a rational person would do--has held increasing sway. Before the efforts of the behavioral scientists, MPT seemed very much to be accepted science. However, markets can become rational only through sufficient interactions of rational (even though imperfect) participants. Real world experiences like a 22% drop in stock prices in just one day (in October 1987) without major economic news, combined with a relatively quick bounce back within a year--or the NASDAQ index soaring above 5,000 in 2000 with companies that amounted to little more than a business plan acquiring large market capitalizations--suggest somewhat of a lack of rationality. This book does a good job covering topics like these and the economists who addressed them, and that's the 95% of the book I truly enjoyed.

This brings me to the end of the book. The book's title suggests a debunking of the myth of a rational market; but despite covering evidence of market irrationality (which has been discussed and successfully exploited by the likes of Warren Buffett for years), Justin Fox doesn't finish the job. He doesn't go in for the kill. Rather, he seems to let modern portfolio theory off with what feels like a draw. Although I would heartily recommend this book for its rich history of the concept of rational markets, in the end I was disappointed.
Get more detail about The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street.