Popular wisdom, backed by much academic literature, holds that markets are inherently efficient a notion strongly challenged by their dizzying ups and downs of the past year.
Paul Woolley, chairman of The Centre for the Study of Capital Market Dysfunctionality at the London School of Economics, questioned the efficient market hypothesis in a timely academic paper released Nov. 20, An Institutional Theory of Momentum and Reversal. Presciently, Mr. Woolley, who first mentioned markets dysfunctionality in a 2003 research paper, created the center in June 2007 just two months before the credit crisis erupted in full force.
I was regarded as an eccentric because of the efficient market paradigm. To imply that markets were dysfunctional seemed somehow irreverent, Mr. Woolley, the centers chairman, said in an interview. Where I was wrong is that the world started to crumble a little earlier than I thought.
According to the LSE economist, investors make seemingly rational, self-serving decisions, buying or selling assets when everyone else does a short-term reaction. But by doing so, they contribute to bubbles and busts.
Hiring and firing managers based on short-term results contributes to momentum effects arising from the clients lack of knowledge about the managers true skills, Mr. Woolley concluded. Isabelle Clary