As recently as five years ago, the evidence wasthought to be unassailable that markets like the New York StockExchange work efficiently--that prices reflect all availableinformation at any given moment in time, so that stock pricemovements resemble a random walk and contain no systematicinformation that could be exploited for profit. Recently,however, substantial departures from the behavior predicted bythe efficient-market hypothesis have been detected. For example,small firms appear to earn inexplicably high returns on themarket prices of their stock, while firms that have very lowprice-earnings ratios and firms that have lost much of theirmarket value in the recent past also earn abnormally highreturns. All of these results are consistent with the empiricalfinding that decision makers often overreact to new information,in violation of Bayes's rule. In the same way, it has beenfound that stock prices are excessively volatile--that theyfluctuate up and down more rapidly and violently than they wouldif the market were efficient.


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