Red-Blooded Risk: The Secret History of Wall Street

Anomalies

It is true that when academics began testing strategies systematically instead of testing conventional investment advice, some anomalies turned up. Small companies did do better than standard academic theory predicted relative to large ones. Stocks that had recently gone up tended to continue up. Companies that were cheap relative to earnings and assets were better buys than expensive companies. Stocks that had either low volatility or low correlation with the market did a bit better than expected. None of these results were suppressed or ignored, but even collectively they amount to a tiny portion of total asset returns. None of these results, or anything comparable, was ever produced by someone who didn't start from the assumption of efficient markets. Only careful quantitative work starting from a clear theoretical perspective was precise enough to discover these anomalies. People who start from the assumption that prices are irrational can explain every price as “someone was stupid.” If you explain everything, you explain nothing, and, worse, you never learn.

It is true that researchers tried hard to poke holes in the anomalies that popped up. That's not blind adherence to theory over reality; it's intellectual honesty. You don't know something is true until you've tried hard to falsify it, and failed. Theoreticians struggled to find efficient market explanations for anomalies. Arguably, the academic community was slow to accept their reality. In 1980, the evidence ...