Red-Blooded Risk: The Secret History of Wall Street

CHAPTER 9

The Secret History Of Wall Street: 1983–1987

At the end of our last episode, we had the rocket scientists arriving on Wall Street to make their fortunes. One hurdle we had to overcome was the idea of efficient markets, which was the dominant academic theory of finance at the time. The idea remains widely misunderstood, mainly because few people bother to read what efficient markets theorists actually write.

Even among professionals who read the literature, you find a lot of evasiveness and confusion about market efficiency. Someone who can't give you a clear answer about whether they believe markets are efficient—or if inefficient, the precise flavor of the inefficiency—cannot manage risk. A typical answer, like “Well, markets are pretty efficient, but I think I can exploit a few small inefficiencies on the margin,” is not helpful. It says that markets are inefficient but the speaker is too timid to say it out loud. The speaker is claiming an ability to beat the market in unspecified ways. The only thing he is clear about is that his successes will not be large or important, and this is precisely the point on which we will agree with him. His failures, however, are likely to be huge. The timid, fuzzy attitude displayed in that quote is the opposite of red-blooded risk taking.

On top of this, that statement robs investment management of any possible social value or even significance. That's not a small point. Anything done only for the money will attract the worst people, ...