The Implications of Behavioral Finance

[Norbert Schlenker]

I came across this on my regular first of the month bookmark scan.

Executive Summary

* Irrational investor behavior is commonly observed by wealth management practitioners when creating and administering investment solutions for their private clients. Many advisors would like to address behavioral issues, but lack diagnostic tools and application guidelines to employ behavioral finance research with clients.
* Many clients would be well served by adjusting their asset allocations to account for biased behavior. By doing so, they would stand a better chance of adhering to their investment programs and enjoy better long-term investment results.
* In applying behavioral finance research to client situations, practitioners must decide whether to attempt to change their clients' biased behavior or adapt to it. Furthermore, quantitative guidelines need to be available when modifying asset allocations to account for biased behavior.
* Practitioners should adapt to biases at high wealth levels and attempt to modify behavior at lower wealth levels. They should adapt to emotional biases and moderate cognitive biases. These actions will lead to a client's best practical allocation.
* Three case studies illustrate how these guidelines are applied. A quantitative model is also unveiled that calculates acceptable discretionary distances from the mean-variance output for determining the best practical allocation.
* The article offers practitioners a framework to better understand how behavioral finance can be applied to their individual clients.

From Pompian and Longo, Journal of Financial Planning

[_PK_]

This short piece from Daniel Kahneman is worth looking at. It has the advantage of pitching the message you want while coming from one of the originators of Behavioral Finance.

Decision Making in the Face of Uncertainty

[Taggart]

The Sunday Times December 04, 2005

Instead he suggests you determine a strategy that does not rely on forecasts. The strategy Montier favours is a value-based approach where you buy stocks that are cheap and have high dividend yields.

“While markets get blown round by sentiment and noise, in the long run it is valuations that determine returns,” said Montier. “The expected return from a stock is equal to the dividend yield, plus any dividend growth, plus any change in valuations that occur.”

Over time, most of the returns from shares come from dividends. If a company is paying a decent dividend, you can make a profit even if the share price doesn’t change.

Sticking to a strategy can also help you to avoid another of his sins, the illusion of knowledge.

Investors believe that the more information they collect the greater the chances of beating the market. But, argues Montier, this is not true.

“Too many investors suffer from information overload so they cannot distinguish noise from news,” he said. “You need to work out what matters, rather than collecting masses.”

He believes that investors also need the self-discipline to take a long-term perspective. They should not buy a stock unless they really believe in it and are prepared to hold it.

While there are likely to be periods of underperformance, if you take a long-term approach you can ride these out.

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HERE are blunders that investors often make and what you can learn from them:

# Ignore forecasts — evidence suggests forecasts are almost always wrong. Use a strategy that doesn’t depend on them.

# Information overload — people often believe that to beat the market they need to know more than everyone else. But studies show increasing information leads to overconfidence rather than accuracy. Concentrate on a few key elements when selecting a stock.

# Overconfidence — most overestimate their investment skills. Set a plan based on your aims and risk profile and stick to it.

# Denial — investors give more weight to information that appeals to them. During the late 1990s investors did not want technology stocks to fall, so they ignored any information suggesting that shares were overvalued. Don’t get complacent.

# Overreaction — many become more optimistic when the market is rising and cautious when shares fall. When a high percentage of investors think the market will go up or down it may be a signal that the opposite will happen.

# Herd instinct — humans feel safer as part of a crowd, which is why investors tend to mimic the behaviour of others and buy fashionable stocks and funds. Turn this to your advantage by picking up stocks that are cheap because they are out of fashion.

# Selective memory — we tend to forget bad decisions but remember successful ones. Keep a record of your decisions, why you made them and whether they were a success — and learn from your mistakes.


http://business.timesonline.co.uk/artic ... 19,00.html

[like_to_retire]

Taggart and his great links are back.......and that's a good thing ltr

[Taggart]

Not ignoring you. Many thanks to members for the warm welcome back.

[Wallace]

# Herd instinct — humans feel safer as part of a crowd, which is why investors tend to mimic the behaviour of others

I think this is the most powerful trap of all - not just as it relates to investing either. It's hard to stand your ground when you're surrounded by lemmings trying to run you off the cliff.

Aye,
Wallace

[Bylo Selhi]

It's hard to stand your ground when you're surrounded by lemmings trying to run you off the cliff.

Then again, they could be trying to escape from the tidal wave that's coming from the other direction

[Wallace]

True, but if you already know that the cliff is there, you can choose the lesser of two evils. Grab your scuba gear, which you craftily stowed under a bush for this very eventuality

Aye,
Wallace

[yielder]

Montier

is an interesting character.

Investments: The psychology of happiness

If you are after specific investment advice, stop reading now, James Montier writes.

We seek to explore one of Adam Smith's obsessions: what it means to be happy.

We also discuss why that's important to investors, and how we can seek to improve our own levels of happiness.

The list below shows our top ten suggestions for improving happiness.

1) Money can't buy you love. Don't equate happiness with money. People adapt to income shifts relatively quickly, the long lasting benefits are essentially zero.

2) Exercise regularly. Taking regular exercise generates further energy, and stimulates the mind and the body.

3) Have sex (preferably with someone you love). Sex is consistently rated as amongst the highest generators of happiness. So what are you waiting for?

4) Devote time and effort to close relationships. Close relationships require work and effort, but pay vast rewards in terms of happiness.

5) Pause for reflection, meditate on the good things in life. Simple reflection on the good aspects of life helps prevent hedonic adaptation.

6) Seek work that engages your skills, look to enjoy your job. It makes sense to do something you enjoy. This in turn is likely to allow you to flourish at your job, creating a pleasant feedback loop.

7) Give your body the sleep it needs.

8 ) Don't pursue happiness for its own sake, enjoy the moment.

9) Faulty perceptions of what makes you happy may lead to the wrong pursuits. Additionally, activities may become a means to an end, rather than something to be enjoyed, defeating the purpose in the first place.

10) Take control of your life, set yourself achievable goals.

Remember to follow all the rules.

Welcome back. Nice to add to the small stock picker's group here.

[Taggart]

Yielder:

Thanks for the list. Now that I've retired from the worklife, as of last week, I can now add them as reminders to my list of "important" things to do in my new life.

As for the "Nice to add to the small stocker picker's group here." I don't know about that. At the moment my list consists of roughly fifteen all Canadian equities, fitting the description of plus 3% yield and dividend growth faster than inflation. Mostly finance and utilities. The only new one on that list is Russel Metals. Haven't bought it yet, but looks like the proverbial $20 bill on lying on the street, and no one wants to pick it up. You see how "behavioral finance" enters the picture again.

[Taggart]

More on behavioral finance from the November edition of Kiplinger's:

BEHAVIOR

Battle of the Binge

Are impulsive money moves wrecking your returns? Here's how to keep yourself in check.

You buy a risky stock impulsively. You beat yourself up over an investment that's losing money, but you can't bear to sell it. You know you should stash more away for retirement, but you never get around to it.

For most investors, these types of seemingly irrational, shortsighted decisions are nearly as automatic as flinching when a bug hits the windshield. But with the help of a new branch of science, called neuroeconomics, investors can learn how to resist their self-destructive tendencies.

http://www.kiplinger.com/magazine/archi ... binge.html

[Bylo Selhi]

Battle of the Binge...

Thanks Taggart. Also worth pasting here:

Follow these other simple rules, and you stand a much better chance of moving the investment decision-making process into the rational part of your brain:

Don't fixate on the short term. A daily, or even hourly, diet of news fires up Mr. Hyde and can trigger fear and greed, two emotions that often trip up investors (see box at left). In the same vein, don't check the prices of your investments too often.

Set long-term goals for your investments. Research has shown that as soon as you stop thinking short term and start thinking about the long term, the emotional part of your brain shuts off.

Diversify and examine the performance of your portfolio as a whole. Big rewards and big losses set off emotional responses. A diversified portfolio evens out these ups and downs.

Set a timetable for when to sell stocks, mutual funds and other investments. That "sell discipline" creates rational goals and preempts emotional reactions.

Throw Mr. Hyde an occasional bone. If you crave excitement, place a bit of your portfolio in a separate account and use that money to speculate on penny stocks, pork bellies or whatever else satisfies your dark side.

[Bylo Selhi]

For determined fund aficionados: Seven Sins of Fund Management [large PDF]

How can behavioural finance inform the investment process? We have taken a hypothetical ‘typical’ large fund management house and analysed their process. This collection of notes tries to explore some of the areas in which understanding psychology could radically alter the way they structure their businesses. The results may challenge some of your most deeply held beliefs.

[NormR]

Thanks, looks interesting enough to print out (105 pgs) and mull over.

Edit: A fine read. Lots of behavioral goodness. Mind you, I'm inclined to like the story ...

[George$]

For those wishing a shorter review of this tome, here is some text from
The Sunday Times, December 11, 2005

But James Montier at Dresdner Kleinwort Wasserstein in London is no ordinary strategist. Unlike many of his peers, he is not content to spend his days crunching numbers and offering up calls to buy and sell. He wants to know what is going on in investors’ heads.

His latest tome, the Seven Sins of Fund Management, focuses on common mistakes made by fund managers and how to avoid them. It provides practical tips, many of which are also useful for the private investor.

The first sin, which he equates to the sin of pride, is to focus too much on forecasts made by financial analysts. They are generally hopeless at predicting.

He quotes a survey that found that when bond-market analysts predicted rising yields, yields fell 55% of the time. Stock- market analysts were equally useless, he said.

[gyrfalcon]

In this thread,

behavioural finance.

Where can I read more on this subject? Sound interesting.

This is not the direct "thing", but for investing, I feel it's solidly based on an understanding of such. I saved it as text, so have no link:

"The Globe's Report on Business Magazine published a profile of Tom Stanley, the highly successful manager of the Resolute Growth Fund (and the new Resolute Performance Fund). After the discussion on three rules, here follow Stanley's 14 rules.

1. Be a long-term investor. Stanley decries the market's obsession with short-term returns, arguing that it's far easier to anticipate longer-term trends. As he says, "I can't tell you what oil is going to be next month, but I think that by 2010, it will be significantly higher than it is now." Thinking long-term means you can also consider investments in less liquid stocks. You're not going to be worried about punting it out next week and taking a loss because it's too thinly traded."

2. Be flexible. Inspired particularly by John Templeton, the idea is to buy whatever stocks provide the best return to unitholders, regardless of sector. Stanley will buy growth issues, but if the market starts paying too much for them, he'll change his focus to value. Resolute Growth, while often classified as a small-cap fund, will buy large-cap stocks if Stanley sees something he likes. Whatever works.

3. Hunt for ideas. Investments should not be made on the basis of "readily available information"--i.e., what everyone on the street knows as well as you do. Instead, do your own wide-ranging due diligence, evaluating companies, management and markets. "There's roughly 4,000 stocks in Canada and we have looked at just about every one of them," Stanley says.

4. Be skeptical of information sources. Always check the facts you have (it helps to have a sound fundamental knowledge of accounting) and strive to understand the biases and potential conflicts of interest among the sources that provide them. Such caution led Stanley to avoid investing in tech stocks before the bubble burst.


5. Invest alongside your clients. Stanley invests all his own money in Resolute's two funds because he believes he should be one with his unitholders. For the same reason, he prefers to buy companies in which management and directors own shares themselves.

6. Buy your best ideas. Stanley concentrates his holdings in comparatively few stocks, in the style of Warren Buffett, so that he knows each of them intimately. "Today, the Resolute Growth Fund has 14 great ideas, 14 stocks," he says. "I don't have 150 good ideas, so I'd rather buy my best 14."

7. Strive for "effective rationality." A favourite mantra of Berkshire Hathaway's Charlie Munger, it simply means that it's vital to sort and grade the quality of information that bombards an investment manager. Or, as Stanley says, "filter out the noise."

8. Be thrifty. Stanley prides himself on Resolute's minimalist office because it saves money. Similarly, Resolute Growth Fund's fees are less than average--a 2.14% all-inclusive management expense ratio--which means more money in the unitholder's pocket. "It's a tough environment out there and you have a much better chance of getting superior returns for your investors if you're charging reasonable fees."

9. Outperform by being different. To produce above-average performance, you have to build a fund that doesn't mimic key indexes. Says Stanley: "We consciously position the fund to be very different from the TSX Index."

10. Know your limits. Stanley is convinced that you can be a more sure-footed investor if you aren't too big or growing too fast. His two funds, Resolute Growth and Resolute Performance, manage slightly less than $450 million in assets between them. Stanley feels he can make fewer and better choices managing this amount than he could if he was handling several billion. Likewise, Resolute Growth was closed to new investors last fall because Stanley felt it was growing too fast for him to continue making thoughtful investments.

11. Stay humble. Templeton once exhorted members of an investment audience to "work at being a humble person," and Stanley subscribes to the virtue wholeheartedly. Hubris, he says, leads to investment failure, but humility breeds an open mind that continually seeks good ideas and is prone to heeding good advice.

12. Stay in your circle of competence. Buffett has often said that investors should stick to what they know. In Stanley's case, that means he stays in the familiar Canadian equity market. "It's easier for me to find opportunities that I can understand here," he says.

13. Be a contrarian. Stanley thinks some of the best buying opportunities can be found in sectors that lack a following or are unpopular. Bull markets, he says, can take a long time to develop, and if you sense a distant upward trend in an industry or sector--as he did with energy--you have to be prepared to buy in and wait, even if your peers look askance.

14. Apply spiritual principles. Templeton teaches that a daily prayer for wisdom can help you avoid making investment mistakes--that those who approach investing in a spiritual way are likely to find greater success. Stanley believes this too, although he also prays to be able to serve his unitholders well. Why? He figures they showed a lot of faith in him in Resolute Growth Fund's first rocky years and he should try to return the favour."

[uhoh]

This is not the direct "thing", but for investing, I feel it's solidly based on an understanding of such. I saved it as text, so have no link:

thanks for posting this - a keeper for sure.

an aside (probably misplaced): the Resolute fund is cashing out soon, right?

[ig17]

behavioural finance.

Where can I read more on this subject? Sound interesting.

BehaviouralFinance.net

[yielder]

Are you a fox or a hedgehog?

On the one hand were the individuals who, generally speaking, saw historical events as driven by some sort of overarching theoretical framework—a metaphysical “force of history,” for instance. Drawing from Isaiah Berlin’s famous distinction, Tetlock labeled these people “hedgehogs,” to reflect their tendency to view political events as (to oversimplify a bit) driven by a single big, theoretical idea.

Tetlock’s other group was—surprise!—the foxes. The fox’s view of history tends to be the opposite of the hedgehog’s: it is determined by multiple inputs, and is not filtered through a single grand theory. Foxes tend to be somewhat suspicious of grand historicist explanations of events; they prefer to base their analyses on multiple, often contradictory viewpoints. They are much more skeptical of their inputs than hedgehogs are, are much more tentative in their conclusions. They tend to be quicker to change their minds in the face of subsequent developments.

And, Tetlock says, foxes outpredict hedgehogs just about across the board. One reason why, apparently, is that hedgehogs are more prone to standard psychological biases that so regularly skew human judgment. Tetlock’s work indicates hedgehogs had greater hindsight bias than foxes do, for example, and were less willing to update beliefs upon the receipt of new information. They were more overconfident in their views, as well.

I resolve to:

1. Pay more attention to evidence that is contrary to my expectations. It’s the easiest evidence to dismiss--and yet often the most telling.

2. Reexamine expected probabilities regularly, in light of new developments--both positive and negative.

3. Spend more time listening to (and understanding!) opposing viewpoints.

More broadly, it’s helpful to lose the habit of believing one’s own b.s.

[NormR]

Are you a fox or a hedgehog?

On the one hand were the individuals who, generally speaking, saw historical events as driven by some sort of overarching theoretical framework—a metaphysical “force of history,” for instance. Drawing from Isaiah Berlin’s famous distinction, Tetlock labeled these people “hedgehogs,” to reflect their tendency to view political events as (to oversimplify a bit) driven by a single big, theoretical idea.

Tetlock’s other group was—surprise!—the foxes. The fox’s view of history tends to be the opposite of the hedgehog’s: it is determined by multiple inputs, and is not filtered through a single grand theory. Foxes tend to be somewhat suspicious of grand historicist explanations of events; they prefer to base their analyses on multiple, often contradictory viewpoints. They are much more skeptical of their inputs than hedgehogs are, are much more tentative in their conclusions. They tend to be quicker to change their minds in the face of subsequent developments.

And, Tetlock says, foxes outpredict hedgehogs just about across the board. One reason why, apparently, is that hedgehogs are more prone to standard psychological biases that so regularly skew human judgment. Tetlock’s work indicates hedgehogs had greater hindsight bias than foxes do, for example, and were less willing to update beliefs upon the receipt of new information. They were more overconfident in their views, as well.

I resolve to:

1. Pay more attention to evidence that is contrary to my expectations. It’s the easiest evidence to dismiss--and yet often the most telling.

2. Reexamine expected probabilities regularly, in light of new developments--both positive and negative.

3. Spend more time listening to (and understanding!) opposing viewpoints.

More broadly, it’s helpful to lose the habit of believing one’s own b.s.

Time to start making wild predictions. I say that the bird flue will strike, killing many and dealing death to the real estate market. Now I'm ready for my TV appearance.

[yielder]

Now I'm ready for my TV appearance.

What the well-dressed TV forecaster should wear. Norm, is that you? The eyes and the hair say yes but the moustache is new. And the glasses are a very good Clark Kentish disguise.

[Bylo Selhi]

Norm, is that you?

Shhh. Don't tell anyone, but that's really me

[NormR]

Norm, is that you?

Shhh. Don't tell anyone, but that's really me

Dang, Bylo got to the paper bags first

[yielder]

[url=http://www.businessday.co.za/articles/markets.aspx?ID=BD4A254173] Scott Huettel, a neuroscientist at Duke University, recently found that the anterior cingulate begins to anticipate another repetition after a stimulus occurs only twice in a row. There’s neural truth in the old saying “three’s a trend”.

When it comes to the stock market, what it means is that as soon as a stock beats earnings forecasts for two consecutive periods, or a fund outperforms the market for two straight years, an “I get it" effect kicks in — the conviction that you know what’s coming next.[/url]

[yielder]

Market Efficiency or Behavioral Finance: The Nature of the Debate., By: Frankfurter, George M., McGoun, Elton G., Journal of Psychology & Financial Markets, 15208834, 2000, Vol. 1, Issue 3/4

Academic finance (also known as financial economics) espouses a methodology that has been largely discredited (or, at the very least, challenged) in all other disciplines, not to mention the philosophy of science itself. And this methodology is so ingrained that it is rarely even addressed, let alone seriously debated. The term behavioral finance, which ought to be applied to a different, more experimental methodological approach to finance, is instead applied to a set of papers that make slightly different assumptions in their mathematics/statistics without even using different methods.

Anomalies

The article immediately continues:

Then, not a formal debate, but a two-and-a-half-hour battle with Gene Fama. His closing comment to me after dinner that evening was "You have pushed me an epsilon toward the abyss." Driving home that night, in a really hard rain, I had a long time to ponder that statement. Why is it an abyss? And why only an epsilon? I concluded that it is only an epsilon because they are afraid of the abyss. And what is in the abyss? The abyss is the realization that we have crossed the line where we can no longer explain most of the market's behavior on the basis of rational economic paradigms.

--Robert Haugen in "Post Modern Finance"

(The International Review of Financial Analysis, 1998, 6:159)

We submit that there never has been, nor ever can be, a direct test of the EMH in any of its forms. Such a test must involve the survey of a "reasonable" (number of) market participants/economic agents, showing them a list of all available information at a certain point regarding a capital asset and asking them to check-mark the information they were aware of and incorporated in their decision making. Of course, such a test is a utopian ideal; thus, all tests of market efficiency are tests of some model (such as the CAPM) that predicts what the price of a capital asset should be if all information were taken into account. The wealth of "effects" discovered in an untold number of studies, published or presented before learned societies, show that the CAPM (or "market model," if we are being cautious) cannot account for any of numerous observed "effects" that are branded anomalies. These include the small firm/large firm, end-of-the-year, end-of-the-month, Monday, Yom Kippur and neglect effects, just to mention the better-known ones. Fama is well aware of that and openly admits that "... the hypothesis that prices fully reflect available information is a faulty description of price formation" (parentheses omitted). Then Fama completely disregards Friedman, and of course all philosophers of science. He argues that, in order to dispose of the EMH, an alternative model that better explains "... price information, itself potentially rejectable by empirical tests," should be formulated, before one is to entertain the disposal of the current hypothesis.

Recall for a moment, if you will, the creation of the world as described in the first chapter of Genesis. Having created the world in six days, God prepares to rest. He retires (de facto creating the Sabbath). He looks around and sees that an hypothesis explaining the mechanism of markets is missing. He creates with great haste the EMH. Because the EMH got there first, by Fama's logic, that part of the creation story of the world can be replaced only by another model that must show more convincingly with much stronger tests than those extant tests of the EMH that the alternative hypothesis holds. Now, to make certain that such an era will never come, the EMH and CAPM are elevated to the level of methodology thereby setting the standard by which all alternative hypotheses must be judged and inevitably found wanting. Because all empirical tests (including those that support the CAPM) can and will be subject to methodological criticism, especially those with results we do not like, the God-created paradigm will hold forever. De Long and Lang (1992) convincingly show that, for a sample of economic papers none of the unrejected null hypotheses were true, and that journals tend to publish papers that do not reject a null hypothesis.

One manifest problem with the Friedman-Sharpe-Fama instrumentalist methodology is the unreality of assumptions. Although this is necessary for the sake of building mathematically tractable models, any resemblance of the results to reality is accidental. This is, in fact, the reason why the financial economists Fama now calls behavioral imported theories from the field of psychology that are more consistent with individuals' behavior. Unfortunately, in many cases their methods of analysis have remained the same as the methods of EMH/CAPM research. Accordingly, if the EMH is often called modern finance, what Fama calls behavioral finance might be called late-modern finance. It is not truly behavioral, a point to which we will return in more detail in the third section.

Anomalies

Synonyms of the word anomaly according to our thesaurus, include: aberration, deviation, digression, exception, irregularity. These many synonyms and definitions are not unique to the philosophy of science. This is an important point, as we shall illustrate.

In financial economics anomaly is commonly used to describe a temporarily inexplicable observation. The implication frequently is that, with a little thought, the unexplained result could be accommodated within one's functionalist world-view. The term, when applied this way, suggests that the user has not even considered the possibility that the underlying paradigm that produced the anomalous result is faulty. The paradigm, in effect, is loftier than the anomaly. Within the confines of the higher truth the paradigm represents, the anomaly is just an aberration, a digression that should be noticed, then simply dismissed or, if need be, tolerated.

This is how Ball (1996), defending the EMH/ CAPM in the face of the behavioral finance onslaught, and others in financial economics use anomaly, to describe an "exception" to a well-established rule or belief. But Ball does not stop here. He tries to convince his readers to accept not only that he was the first to find evidence of an anomaly as far as the EMH goes (Ball and Brown, 1968), but also that he introduced the concept "... to the financial economics literature in a paper [I] published in 1978 ..." (ibid., p. 11).

In footnote 33, Ball (1996) indicates that his use of the word anomaly in Ball (1978), was "borrowed" from Kuhn's (1970) "famous book ... which introduced the term to the philosophy of science and scientific method" (ibid., p. 13). This may be a bit presumptuous. The word anomaly without a doubt appeared in the literature even earlier, and we distinctly remember seeing it in a work published in 1977 in the Journal of Finance. The word was used there to report an anomalous finding regarding the Modigliani and Miller (1958) and Miller and Modigliani (1966) works (Boness and Frankfurter, 1977, p. 775 and p. 786).

All that said, one still must take a closer look at Kuhn (1970). Following is an early paragraph in which Kuhn first uses the word anomaly. Note that he does not put the word in quotation marks as he does for new nomenclature elsewhere in his book. He seems to be using anomaly just as the appropriate word to describe the phenomenon.

Discovery commences with the awareness of anomaly, i.e., with the recognition that nature has somehow violated the paradigm-induced expectations that govern normal science. It then continues with a more or less extended exploration of the area of anomaly. And it closes only when the paradigm theory has been adjusted so that the anomalous has become the expected. (ibid., page 52)

Another important point is that anomalies, according to Kuhn, eventually cause the modification (adjustment) of the paradigm. No such thing can be observed regarding either the EMH or the CAPM.

Scientific thought does not exist in a vacuum. To the contrary, it evolves and develops within an existing belief system. Scholars of the Middle Ages never thought of electromagnetic waves because they could never even imagine, let alone believe in, their technological reality, yet today electromagnetic waves are important instruments in the discovery of new physical phenomena.

The existence of a belief system is even more important in the social sciences, where there are no tangible technological discoveries that result in concrete inventions such as CD-players, camcorders, or digital cameras. What we have in the social sciences are models that may or may not describe human behavior. Positive economic models in particular are suspect because of the "unreality" of their assumptions. These models, of course, are direct consequences of a system of beliefs, which, as in the case of the CAPM, for instance, are now recognized as a matter of an idiosyncratic view of the world; that is, what segment of market data one looks at.

It is not our intention to critique Kuhn (1970), as more qualified people have done that already.[ 3] Our aim is to point out that Kuhn serves well the interests of scientific elite in the social sciences because these disciplines are not capable of technical discoveries. There is no economic equivalent of the camcorder or CD-player. A reviewer can easily suppress articles postulating a new paradigm, or venturing to critique an old one. All he or she has to do is to argue that the paper is "poorly written." On the other hand, for an established model, as long as the "right" people accept it for whatever reason, others wielding data and statistical tests will find empirical support for its existence. And there are always data and statistical tests to reject inconvenient findings as weak or non-existent. This is precisely what Fama (1998) does on a massive scale. In attacking the inconvenient results of tests based on more realistic assumptions than those of the EMH, Fama aims to discredit the methods of analysis on one ground or another. As a result, the anomalies are either made to disappear or declared "weak," and the methodology is rejected. Thus, such behavior ensures the eternal existence of a paradigm that cannot possibly be true because its assumptions are totally at variance with almost everything we know about human nature and behavior.

The state and status of the EMH are perhaps best described by the following paragraph (reproduced here with his permission) taken from our private correspondence with Myron Gordon, responding to an earlier draft of Frankfurter and McGoun (1998):

Roughly one third of the literature [of the EMH] is devoted to the more elegant elaboration of the theory, much like the paintings of more and more representations of Christ in the Middle Ages. One third is devoted to exploring the theoretical implications of one or another imperfection--viewed in isolation. The balance is devoted to tests that demonstrate the presence of anomalies, i.e. Fama and French. Of course, as you note, the possibility of an alternative paradigm is not ever considered, and it is stomped on wherever it rears its ugly head. Hence, ideologues remain secure in the belief that with all its imperfections there is no alternative to the theory of PCCM [perfectly competitive capital markets].