work, and his results were ignored to a large extent. Bachelier lived out the rest of his life in relative obscurity, and he died without fame in 1946. Not too long after his death, however, the concepts that Bachelier invented were reformulated as the efficient markets hypothesis that swept through universities and onto Wall Street in the 1970s.3

In the words of Burton Malkiel, author of A Random Walk down Wall Street, the modern version of Bacheliers insight is Even a dart-throwing chimpanzee can select a portfolio that performs as well as one carefully selected by the experts. Malkiels book was published in 1973, and it was part of an enormous intellectual wave that restructured the investment world.4

If the efficient markets hypothesis is true, then an investor need never fear buying overpriced stocks. According to the hypothesis, stocks are never overpriced and markets can never be mean.

During the great bull market of the 1980s and 1990s, belief in market efficiency and stock ownership soared. On the 1998 edition of Professor Jeremy Siegels Stocks for the Long Run, the dust jacket proclaims, stocks are actually safer than bank deposits! (Emphasis and exclamation point in the original.)5

The idea that stocks are safer than bank deposits sounds a bit silly today (and has been removed from the dust jacket of later editions of Professor Siegels book). Nevertheless, if markets are rational, then Professor Siegels advice that stocks should constitute the overwhelming proportion of all long-term financial portfolios might be reasonable.

If markets are not rational, however, then investors ought to worry about buying stocks at irrationally high prices. They should also worry about selling stocks at irrationally low prices. They should also be concerned about the prices of houses, bonds, gold, and all assets.

The essence of the efficient markets hypothesis is realizing that a good deal for one person implies a bad deal for the other. Thus, no one should be willing to sell at irrationally low prices and no one should be willing to buy at irrationally high prices.

The efficient markets hypothesis is a beautiful theory. Is it true?

If Shes Got Pictures, Deny It! . . .

It wasnt me.

The pop star Shaggy gives this advice to men caught cheating. Honey came in and she caught me red-handed, creeping with the girl next door. The correct response to being caught cheating, according to Shaggy? Deny by saying it wasnt me. Even if caught on camera, Shaggy sticks to his defense of it wasnt me.

The great comic Lenny Bruce expressed a similar philosophy in one of his routines: Theres this kind of guy who says: When I chippie on my wife, I have to tell her, I cant live a lie, have to be honest with myself.

To which Bruce replies, Man, if you love your old lady, really love her, youll never tell her that! Women dont want to hear that! If shes got pictures-deny it!...Gee, honey, I dont know how this broad got in here-she had a sign around her neck, I am a diabetic-lie on top of me or Ill die. No, I dont know how I got my underwear on upside down or backwards.

Those who defend the efficient markets hypothesis use a similar tactic of denial. In response to evidence of market irrationality, the response is denial. (It wasnt me.)

There are examples of market irrationality that appear as convincing as photographic documentation of infidelity, and they are everywhere around us. For example, financial bubbles have occurred in every society throughout history that has had markets. The most famous case is the seventeenth-century Dutch tulipmania. In 1635, at the height of speculative frenzy, the price for a single tulip bulb exceeded that of a nice house in Amsterdam.6

How could it be rational to buy a tulip bulb for the price of a house? This seems particularly strange given that one tulip bulb can produce an infinite number of baby tulip bulbs. While tulips may not breed like rabbits, they do multiply rapidly and thus high prices are impossible to sustain. In fact, the Dutch tulip crash came swiftly, with some varieties losing 90% of their value in a matter of weeks. (By comparison, after its

peak in 2000, it took Sun Microsystems two years to lose 90% of its value.)

The high price of tulip bulbs before the crash and their rapid decline appear to be evidence of market irrationality. As we will come to see, true believers of the efficient markets hypothesis deny that bubbles and crashes imply that markets are irrational. (It wasnt me.)

While markets continue to behave as they have for centuries, the debate on irrationality has changed dramatically in recent years. The field of behavioral finance has produced new, scientific evidence of market irrationality. In many cases, the new studies provide statistical confirmation of folk wisdom.

Lets take a look at some compelling evidence of market irrationality- both historical and new-and the response of those who deny it. (If you are already convinced that markets are irrational, you can jump down to the section entitled Why Professors Fly Coach and Speculators Own Jets. ) I argue that it is impossible to prove that markets are irrational, but the evidence is compelling. To which, of course, true believers in the efficient markets hypothesis will reply: It wasnt me.

Claim #1: Stock Market Crashes

On Monday, October 19, 1987, the Dow Jones Industrial Average lost 23%. By noon of the following day stocks faced a crisis where some people feared a total collapse of the stock market. The U.S. Federal Reserve, led by a recently appointed Alan Greenspan, rode to the rescue by guaranteeing certain trades. The market recovered in the afternoon of October 20.

Many people have investigated the 1987 stock market crash. Of note, independent studies were performed by Professor Robert Shiller, the author of Irrational Exuberance, and by his friend Professor Jeremy Siegel, the author of Stocks for the Long Run.1

These two leading academics are often on opposite sides of the stock