The Efficient-Market Theory Is the Perfect Competition Model of the Financial World

Many economists do not believe that you can beat the market. That is, they believe that investors cannot consistently make big money in stocks, commodities, or any other financial market. I heard this peculiar view when I was an undergraduate, and it is still very much in vogue among academic theorists. It’s called the “efficient-market theory,” and it remains the dominant theory in finance schools. Samuelson and Baumol and Blinder discuss it favorably, and proponents of rational expectations often support it. It is the notion that markets are extremely efficient in the sense that in them all new information is quickly discounted. Therefore, no one can capture consistent profits by trading stocks, commodities, or options. As Samuelson summarizes, “You can’t outguess the market.” I call the efficient-market theory the perfect competition model of the financial world. . . .

The best alternative, say the armchair theorist, is to select stocks on a random basis. This is called the “random walk method” of investing. The most popular book on this subject is A Random Walk Down Wall Street, by Burton G. Malkiel, dean of management at Yale University. Malkiel defines random walk as follows:

A random walk . . . means that short-run changes in stock prices cannot be predicted. Investment advisory services, earnings predictions, and complicated chart patterns are useless. . . . Taken to its logical extreme, it means that a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by the experts. 

While Wall Street analysts often dismiss the random walk method as academic nonsense, mainstream economists are enamored by it.

—Mark Skousen, “The Economist as Investment Advisor,” in Economics on Trial: Lies, Myths, and Realities (Homewood, IL: Business One Irwin, 1991), 257-258.