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Why the Efficient Markets Hypothesis Is a "Half-Truth"

Late last month, Robert Shiller stopped by Motley Fool Headquarters for an hour-long interview about housing, stocks, bubbles, and more. A Yale professor who just published his 10th book, Finance and the Good Society, Shiller is an expert on a variety of economic topics.

Given his clout within the field, I asked him about the biggest change in his investment thinking over his long career (he's been a professor at Yale since the early 1980s).

In the video below, see why he thinks the efficient markets hypothesis is a "half-truth," and see what he thinks is really driving the markets these days. (Run time is 2:19; a transcript is below.)

Brian Richards: What has been the biggest change in your investment thinking over your career?

Robert Shiller: Over my career? That's a long time. I used to be cowed by the efficient markets hypothesis, and now I think it's a half-truth. It is true that money is harder to make a profit than you'd think, and randomness plays a huge role in your outcomes, investing outcomes. But it's not true that markets are efficient, and in particular, aggregate markets are driven primarily, I believe, by investor sentiment.

So I have been involved for decades now in behavioral finance, which is academic study of psychology and finance together, and I think this is hugely important. The most exciting thing that's happened in academic finance is all this behavioral research. It's now becoming augmented with neuroscience research, and that's the new, new thing. They're putting investors under magnetic resonance imaging and observing their brain during their thought processes about investing. And this will change the way finance is done.

Richards: You mentioned you'd been studying behavioral finance for a number of years. Are you seeing that investors are still falling for the same biases that they were when you started in this field, or has this sort of improved discourse about what we're prewired to think and to do, has that helped change any of the behaviors?

Shiller: Well I think that it's gradually getting better. Markets are getting more efficient. So the momentum effect in the stock market was stronger in the years 1881 to 1941 than they are now. But we still have a momentum effect. We still have new people coming up and making the same mistakes that have always been there. We haven't all become savvy.

For more insights from my talk with Robert Shiller, see:

Brian Richards is the managing editor of Follow Brian on Twitter: @brianlrichards.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 16, 2012, at 1:00 PM, DJDynamicNC wrote:

    That people are irrational and make decisions with limited information and a great deal of subjective emotion is news only to economists.

  • Report this Comment On April 16, 2012, at 4:55 PM, miclombardo wrote:


  • Report this Comment On April 16, 2012, at 5:04 PM, miclombardo wrote:

    "...[professors] say that the market is efficient in the sense that there is no particular point in getting more information than people already have. That may be true, but the idea of saying that the fact that the information is so widely spread that the resulting prices are logical prices - that is all wrong. I don't see how you can say that the prices made in Wall Street are the right prices in any intelligent definition of what right prices would be"

    Ben Graham, "An hour with Mr. Graham", Financial Analyst Journal, Nov/Dec 1976

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