Death Of The Efficient Market Hypothesis

Min Deng*

Shenzhen Divine Vision Investment Planning Co., Ltd







* Email: dengmin@public.szptt.net.cn


To my friend
Mr. Chen Yuping
Without his generous one million RMB funding support, this
research could never have been completed.















Acknowledgements
Copyright by the author. All rights reserved. No part of this publication may be reproduced, stored in a
retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or
otherwise, without the prior written permission of the author.




Death Of The Efficient Market Hypothesis
Min Deng
Shenzhen Divine Vision Investment Planning Co., Ltd
Abstract
This report summarizes the breakthroughs achieved by the present writer in
respect of the research on the investor behavior and stock price behavior as well as the
interrelationship between them.
On the basis of these achievements, the paper briefly analyzes the theory of
random walk, and point outs its main errors. The paper then dwells on details
identified with the errors and mistakes associated with the Efficient Market Theory.
The paper also provides an in-depth analysis into the basic elements constituting the
Efficient Market Theory (such as Rational Expectations and equilibrium) and
pinpoints the underlying non-scientific aspects in this regard, and provides a brief
judgment on the viewpoints advanced by Samuelson (1989), Fama (1998) and
Malkiel (2003), (2005).
Lastly, the paper concludes with the fact that Efficient Market Theory is far from
a reasonably close approximation to the stock market realities, and its scientific
content is close to zero.
Moreover, the paper provides brand-new interpretations on whether those
extraordinary investors who have succeeded in beating the market actually depended
on luck or not along with a number of other financial theoretical problems related to
the Efficient Market Theory.

Keywordss Investor behavior; stock price behavior; theory of the random walk;
Efficient Market Theory
JEL Classification: G14.

Table of Contents

1 Introduction............................................................................... 1
2 The Investor Behavior and Stock Price Behavior................... 5
2.1 The investor behavior.......................................................................................................5
2.2 The stock price behavior................................................................................................10
2.3 Inter-relationship between the investor behavior and stock price behavior...................14
3 A Historical Perspective on EMT........................................... 16
3.1 Pre-history Stage Of EMT (1900 1965)...................................................................16
3.2 Formation And Refinement Stage Of EMT (1965 1991).........................................18
3.3 EMT At the Stage Of Decline ( 1991 Present).........................................................21
4 Analysis of Errors with The Theory of Random Walk......... 23
4.1 Mistakes with perception...............................................................................................23
4.2 Erroneous research methodology...................................................................................25
4.3 Root cause analysis........................................................................................................27
5 Analysis on Errors with EMT................................................ 28
5.1 Absurdities with the efficient market definition.............................................................28
5.2 Unscientific theoretical models......................................................................................30
5.3 Assumptions and Theoretical Basis for EMT ................................................................34
5.4 Other mistakes................................................................................................................36
6 Analysis of Basic Elements Constituting EMT..................... 37
6.1 Rational Expectations theory.........................................................................................38
6.2 Rational Investor............................................................................................................46
6.3 Arbitrage........................................................................................................................49
6.4 Equilibrium....................................................................................................................51
6.5 Is EMT the reasonable approximation of the reality?....................................................54
7 Commentaries on EMT Theorists Viewpoints ..................... 64
7.1 Viewpoints advanced in Samuelson (1989) paper .........................................................65
7.2 Fama (1998)...................................................................................................................69
7.3 Malkiel (2003) and (2005).............................................................................................71
7.4 Malkiel (2003)................................................................................................................74
8 Concluding Remarks............................................................... 82
8.1 Summary........................................................................................................................82
8.2 Commentary...................................................................................................................83
Bibliography .................................................................................. 86


1 Introduction
1
They (market inefficiency) exist because we do not root out their basic causes.
These causes are easy enough to identify, if one looks with enough dispassion and
rigor.
2
------------Dean LeBaron
Efficient market theory
3
(EMT) is generally regarded as the cornerstone of the
mainstream financial theories. Fama (1970, p. 383) provides a classical definition
on the efficient market:
A market in which prices always fully reflect available information is called
efficient.
Underlying this definition is the economists assumption that the stock market
investors are rational agents and that the stock price is determined by their
interaction.
4
According to Frederic S. Mishkin, a more straightforward efficient
market definition can be provided as follows: in an efficient market, there is no
earning opportunity that has not been fully utilized.
5
EMT advocates proclaim that
the real-life stock markets (such as the US stock markets) are consistent with the
above definition of efficient market.
In the 1970s, EMT had, for a certain period of time, been looked upon as a
scientific truth turning countless young economists and financial students into its
faithful disciples. With the emergence of the anomalies
6
in the stock markets in
the 1980s and the 1987 stock market crash, EMT had aroused widespread suspicions

1
In this paper, the present author has made extensive references to the contents of the works by such distinguished
economists and finance professors as Paul A. Samuelson, Eguene F. Fama, Burton Malkiel, Stephen LeRoy and
Frederic Mishkin. The present author acknowledges his sincere appreciation and regards to the foregoing
scholars.
2
LeBaron (1983). Quotation.
3
Efficient market theory (EMT), in a broad sense, refers to efficient market hypothesis (EMH). In the context of
this paper, both terms share the identical meaning.
4
LeRoy (1989). See Page 1613.
5
Mishkin, Frederic S., The Economics of Money, Baking, and Financial Markets, Chinese edition, China Renmin
University Press. See Page 660. Quotation.
6
Anomaly refers to unexpected event, which could bring opportunities for investors to earn abnormal return, such
as seasonal anomalies, etc.
1

of the academic and investment management circles with regards to its scientific
nature. With the coming into fashion of Behavioral Finance in the academic circle
and the irrational exuberance in the US stock markets in the late 1990s, the
academic circle witnessed a major changeover in its attitude towards the EMT.
Some scholars believed that EMT should be abandoned, as in the case of Haugen
(1995) and Shiller (2000). Some other scholars took the view that EMT should still
play the role of a useful benchmark. A minority of scholars insisted that EMT
accurately recapture the realities as in the case of Malkiel (2003), (2005).
For the following three reasons, the academic circle has been unable to ascertain
whether EMT should be viewed as a scientific school of thought.
(i) Problems with EMT itself. First and foremost, the definition of efficient
market given by Fama (1970) was far too vague. According to Beaver (1981, p. 23):
The problem is not simply that concepts are difficult to test empirically, a
pervasive phenomenon not unique to the efficient Market literature, rather, the
problem is that, at a conceptual level, prior to empirical testing, it is unclear what is
meant by the term market efficiency.
Moreover, fully reflect in this particular context is not specified in any way, and it is
not possible to ascertain it.
Second, it had taken EMT more than 20 years from birth to final refinement.
During this period, Fama (1976) had strengthened the definition of efficient market.
And Fama (1991) carried out major revisions on the definition and description of
EMT.
(ii) Human factors. EMT may be described as the crystallization of years of
incisive research work conducted by scholars and pundits fully devoted to the study of
the behavior of stock price. As such scholar grouping enjoys high prestige in the
academic circle plus their religious faith in the accuracy of EMT, conclusions drawn
by those scholars opposed to the views of EMT have not received the same level of
attention. And research conclusions deviating from EMT viewpoints are invariably
questioned.
2

(iii) Technical difficulty. With the Capital Asset Pricing Model becoming the
mainstream financial theory and the birth of the Rational Expectations Hypothesis,
theorists managed to integrate EMT with CAPM along with Rational Expectations
Hypothesis. And such integration made it extremely difficult to ascertain whether
EMT was a scientific theory. To confirm whether EMT is a scientific theory or not,
we must have in place a scientific stock pricing model to explain the stock price
behavior and investor behavior. As scholars entertaining a questioning attitude at
EMT have not been able to achieve any major breakthrough regarding the stock price
behavior and investor behavior, it was not very difficult for us to comprehend why the
research work conducted by a number of established economists and finance
professors, such as Shiller (1981), DeBondt and Thaler (1985), Lo and Mackinlay
(1988), J egadeesh and Titman (1993), Shleifer and Vishny (1997), Haugen (1997) had
been unable to challenge the status of EMT as the cornerstone of the modern financial
investment theories.
In the early 1990s, the special environment at the time of the birth of Chinas
stock market has provided a precious opportunity for people involved in studies on
the actual investor behavior and stock price behavior. The present writer has had the
luck to experience the entire process. Through unrelenting efforts over 14 years, the
present writer has finally achieved a breakthrough in respect of the research
associated with the investor behavior and stock price behavior. By relying on the
breakthroughs achieved on the investor behavior and stock price behavior, we are
already in a position to formulate a correct judgment on the puzzle of whether EMT is
scientific or not.
The specific method is as follows. First of all, the present writer set up a simple
analysis framework to analyze the actual investor behavior and stock price behavior.
Secondly, the present writer regard the foregoing research conclusions in the above
framework as the reference standards to perform comparative analysis on the
scientific connotations of the basic elements related to EMT as employed by the
economists (such as equilibrium, Rational Expectations Theory and rationality and so
forth). Lastly, the present writer perform a comparative analysis on the possible
outcomes arising from the integration between these essential elements constructing
the EMT by the economists versus the basic elements of our analysis frameworks in
terms of integration.
As EMT is but a simplified replica of the stock market realities, we are not in a
3

position to demand that it should be consistent with the actual stock market realities in
all aspects. As a scientific theory, EMT is only required to be the reasonable
approximation of the stock market realities. The crux of the matter lies in what
constitutes the criteria for the reasonable approximation? The present writer has
divided the stock market reasonable approximation criteria into the following 3
aspects: Whether EMT scientifically recaptures the investor behavior; whether EMT
scientifically describes the stock price behavior; whether EMT scientifically reflects
the interrelationship between the investor behavior and stock price behavior.
Based on the above criteria, this paper has carried out a full comparative analysis
on the EMT. The concluding part of the present report demonstrates that: EMT is by
no means the reasonable approximation of the stock market realities, and its scientific
content is close to zero. The reason is pure and simple: EMT absurdly describes the
investor behavior and mistakenly represents and explains the stock price behavior.
Furthermore, EMT wrongly captures the inter-relationship between the investor
behavior and stock price behavior.
This paper is primarily intended for the academic and investment management
circles. The present writer very much hope that his research achievements will be
conducive to the academic and investment management circles in correctly judging
whether EMT is scientific or not. And it is conducive to assisting others to obtain a
scientific understanding of the nature of the stock market as well as the actual stock
price behavior.
To better clarify the mistakes associated with EMT, the present writer has
divided EMT into three stages, viz. pre-history of EMT (1900--1965), EMT formation
and refinement (1965--1991) and EMT decline (1991--to date). This paper is
arranged in the following sequence: Section 2 briefly outlines the analysis framework
formulated on the basis of the present writers research results associated with the
investor behavior and stock price behavior. Section 3 takes a brief look at the
evolutionary history of EMT. Section 4 analyzes errors and inadequacies identified
with the theory of random walk which precedes EMT. Section 5 describes and
analyzes the errors with the EMT. Section 6 provides a comparative analysis on the
basic elements used by the economists to formulate EMT. Section 7 brings together
Samuelson (1989), Fama (1998), Malkiel (2003) and (2005) research conclusions for
judgment. Section 8 provides concluding remarks on the underlying causes relative
to the errors with EMT.
4


2 The Investor Behavior and Stock Price Behavior
In order to provide a scientific description and forecast of the stock price
behavior in real life, we must obtain a scientific understanding of the
inter-relationship between the investor behavior and stock price behavior. To do
this, the prerequisite is that we must have in place a scientific description of the
investor behavior and stock price behavior.
2.1 The investor behavior
To have a scientific description of the stock price behavior, the most
fundamental condition is that we must provide a scientific description of the investor
behavior in the stock market. To scientifically describe the investor behavior, the
precondition is that we must have a scientific understanding of the investor behavior.
In respect of investor behavior, we are required to understand the human nature, the
limits of human brains, the investor ideal, investor expectations and investor
decision-making.
Human nature
The Wealth of Nations by Adam Smith is generally regarded as the Bible of
economics. In the foregoing book, Adam Smith laid emphasis on the self-seeking
nature of human beings. Another great book by Adam Smith entitled The Theory
of Moral Sentiments has not merited the same level of attention. In the book, Adam
Smith placed premium on the selflessness of human beings. Perception by Adam
Smith of human nature is comprehensive and profound: only by integrating
economical selfishness with moral selflessness can we hope to understand the
comprehensive true human nature.
7
Unfortunately, human selflessness has not
become one basic assumption for economics in the same way as human selfishness.
Understanding the true and full human nature is of crucial importance to our
understanding of the stock price nature and actual stock price behavior. This is
because: if we only know that human beings are selfish without knowing their

7
Smith, A., 1904, An Inquiry into the Nature and Causes of the Wealth of Nations, Chinese edition. See
Introduction, p. 4--5. Quotation.
5

altruism, it would be very difficult for us to comprehend why people tend to unite
closely together to defend their common interests when individual selfish acts harm
others interests without bringing good benefits to themselves. Over 100 years ago,
the phoenix tree outside of the No. 68 of Wall Street showed such a spectacle. To
defend their common interests, over 20 stockbrokers joined hands to sign up the
famous Buttonwood Agreement to lead to the eventual birth of the New York
Stock Exchange.
8
If the investor is like the rational investor under EMT
assumptions, the stock market could not have come into being in the first place.
Limits of human brains
In 1956, the psychologist George Miller issued a famous paper the magic
number seven plus or minus two highlighting some limits on our capacity for
processing information. In the report, George Miller pointed out that the channel
capacity for processing information on the part of human brains appears to be limited.
The typical range is epitomized by the magic number seven plus or minus two.
Inspired by the research conclusions of George Miller, the present writer has carried
out substantial research on the channel capacity of the framework in terms of human
brains forming expectations of the future stock price.
The present writers research conclusions indicate that the channel capacity of
the framework for forming expectations of the future stock price on the part of the
human brains is very close to the conclusions drawn by George Millers research
work. Under specified time frame (yearly, monthly and daily), the human brains
channel capacity for containing stock price quantities stands at number seven plus or
minus two. That is to say, the human brains channel capacity for formation of stock
price expectations are limited to number seven plus or minus two. If the human
brains are compared to a forecasting machine, the human brains oriented stock price
quantity to the input and the expected conclusion to the output, the output will be far
less than the input quantity. That is to say, although the framework space within the
human brains for anticipation and forecasting is 72, When forecasting the stock price,
the human brains are only capable of having expectations of the stock price of any
statistical significance less than 7 unit time, In real-life environment, as the stock
market is full of mutually contradictory information, the investor can only have

8
Gordon (1999), The Great Game: The emergence of Wall Street as a world power: 1653-2000, Chinese edition,
Citic Publishing House. See Chapter 2. Quotation.
6

forecast of stock price within 1 to 3 unit time that is of any practical statistical value.
The investor ideal
All human creations are reflections of mankinds pursuit of determinism. Such
is the case with the civilized society, literature, music and fine arts. As one of the
greatest inventions of mankind, stock market clearly reflects investor aspirations.
In addition to the material home for the human being, there is a spiritual home.
And human ideal is to hold sway at the spiritual home. Apart from a visible world,
the investor also possesses an ideal world. Human ideal realm is one of determinism,
it is totally incompatible with the random realm of throwing dices as is the order of
the day in the gambling process.
It is of paramount importance to understand the investor ideal vis--vis the
investor behavior and stock price behavior. The investor ideal constitutes the core
foundation for the birth and development of the stock market. The investor
aspiration constitutes the major driving force for the investor in terms of the purchase
of stocks. The stock price embodies the aspirations of the investor. As the stock
market embodies the aspirations of all the investors, all stock markets evolve towards
the orientation of the investors ideal stock market.
In the investors idealized stock market, due to all the investors holding fully
identical viewpoints on the history, present and near-term future of the market and
fully understand their own respective strengths and weaknesses, the market price will
only rise and never fall. The market price track is so clear-cut that prediction
becomes superfluous. Any new information, however good or bad, will not exert
any influence on the formation of the stock price. The reason is that, in an idealized
stock market, the investor is fully rational to such an extent that the market is strong
enough, this is very much like a healthy person (his own health being a source of
disease resistance or prevention) would not contract cough or catch cold in the wake
of sudden change in climate. In the idealized market, the stock price is equivalent to
its value, and the investor is completely rational. The investor does not need to
consider any specific investment strategy at all.
The idealized stock market is not a virtual market. Rather, it is the target that
all the current stock markets are striving for at this point in time. We can easily find
the shadow of the idealized stock market amongst the sways of the real-life stock
market tendencies, and feel the pulse of the real-life stock price in moving towards the
7

ideal stock market. For example, in the short term, any stock price index sequence
exhibits tendencies of more increase than decrease. In the long term, the stock price
indexes of the countries all over the world have been steadily on the increase, and
have not dropped below their respective initial starting points in the form of random
walk. The most obvious example is that, over the 100-odd years, the DJ IA has shot
up from its initial 50 points to over 14000 points.
Investor expectations
The investor relies on his own innate patterns to form expectations on the future
movement of the stock price. In forming his expectations of the future stock price,
the investor invariably has three kinds of expected values. These are the intuitive
prospect value, the momentum prospect value and historical experience-based
prospect value. It is rather easy for us to observe the intuitive prospect value and the
momentum prospect value. But it is rather difficult to judge the historical
experience-based prospect value, as it is a kind of statistical expected value.
The intuitive prospect value epitomizes the expectation formed by the investor
on the past stock prices. It is consistent with human nature, and, as a result, each
and every investor can engage in the intuitive expected value.
The momentum prospect value takes shape on the basis of the intuitive expected
value. It is an expectation arising from the price differential between the investor
forecast price and the realized stock price.
The historical cvncpgc ac+`_qcb prospect value refers to the expectation
arising from statistical conclusions drawn from the stock price patterns in recent
periods of time on the part of the investor in relation to the entire stock price historical
sequences showing similar patterns. Generally speaking, an investor needs a
minimum of 5 years of study of the market statistics to form the historical
experience-based prospect value. The historical experience-based prospect value
plays a pivotal role in the decision taken by the investor of a scientific nature.
Purely from the future expectancy standpoint, a veteran Wall Street pundit who has
spent over 3 decades in the area of financial analysis cannot said to be more accurate
than a newcomer to the Wall Street in terms of the forecast of tomorrows stock price
movement. However, from an investment decision point of view, a veteran Wall
Street pundit who has spent over 3 decades in the area of financial analysis will
certainly be able to arrive at a more reasonable investment decision than a green hand
8

at the Wall Street. This is because a newcomer can only rely on his intuitive
expected value and the momentum prospect value to reach an investment decision,
and he is simply unable to form precise historical experience-based prospect value.
The way that the investor anticipates the future stock price determines that the
investor can only predict the future stock price on the basis of the past and present
stock prices. The concept of discounting raised by the economist is not a basic
approach used by the investor to predict the future stock price in any way. It is only
an empirical methodology derived from the foregoing three approaches.
Discounting approach should not be used separately from the three basic modes of
investor expectation in the stock market.
It should be mentioned that, as the channel capacity of the framework for
forming the expectations of the future stock price on the part of human brains appears
to be limited, in forming expectation of the future stock price,
non-stock-price-information (such as interest rate increase by the US Federal Reserve
Bank and new products being unveiled by the listed companies etc.) cannot make its
way into the stock price expectation system on the part of the investor. Such
non-stock-price-information enters the expectation system that is independent of the
investors stock price expectation system. After going through the processing of the
investors expectation and cognition systems, what the investor eventually gets is no
longer the expected values of the non-stock-price-information, rather, it is qualitative
rather than quantitative assessment on the future stock price on the basis of the
expected values of the foregoing information. These assessments along with the
three expected values of the future stock price jointly make their way into the
decision-making system of the investor.
Investor decision-making
The investor decision-making system mainly comprises four parts, namely, the
investors 3 expected values, the investors assessments of the
non-stock-price--information, current earning/loss-making situation of the investor
and requirements imposed on his own behavior on the part of the investor. How the
investor takes his decision is dependent upon the outcome of the integration of the
foregoing four parts within the investors decision-making system. There are
thousands of investors in the stock market and the outcomes of the integration of the
foregoing four parts within the investors decision-making systems are miles apart, so
9

there will be investors buy and sell stocks at any price point in any time interval in the
stock market. Success on any one of the stock transactions in the stock market is not
because of the same sort of expectations of the involved stock price on the part of the
investors in the market at the time, mainly because the outcomes of the integration of
the foregoing four parts within the investors decision-making systems of the buying
and selling investors are different.
2.2 The stock price behavior
Only on the basis of having obtained a scientific understanding of the above
investor behavior is it possible for us to really comprehend the stock price behavior.
To analyze stock price behavior, we must, first and foremost, understand the nature of
the stock price movement and the prospect values of the stock price sequence.
Secondly, we are required to understand the patterns of the movement of the stock
price and the rules governing the stock price movement. Finally, we must
understand the stock price behavior in the absence of external information
interference.
Nature of the stock price movement
From a macro point of view, the stock market is not a gambling outlet. Rather,
it is a place where the investor harbors their aspirations and ideals. The trend of
stock price movement reflects a delicate balance between aspirations and expectations
of the realities on the part of the investors. And the rising trend of the stock price
represents the direction of the investor aspirations. From a micro standpoint, as any
one stock price sequence embodies investor aspirations and prospect values, any one
stock price sequence should be considered as a source of generic information. Such
generic information differs, in substance, from the outside information (such as the
news released by the Federal Reserve Board and the Iraqi war etc). It constitutes the
core driving force associated with the stock price movement. Because of the reason
that any random time sequences or emulation stock price sequences cannot embody
the two elements of the investor prospect values and investor community collective
aspirations. Consequently, any random time sequences or emulation stock price
sequences arising from gambling table, throwing dices and random cards lottery are
incompatible with the real-life stock price sequences in terms of substance. The
allegation that stock price movement is the result of noise is a totally mistaken
10

representation of the root cause leading to the stock price movement. J ohn Maynard
Keynes is also wrong in asserting that the stock price movement is motivated by
animal spirit.
The prospect values of the stock price sequence
The stock price at a unit time interval represents the basic unit of a stock price
sequence, it is composed of three elements, viz. direction of stock price movement,
magnitude of the stock price movement and stock price movement unit intervals.
The history sequence of the stock price is in fact, a sequence composed of these three
elements. As the stock price behavior is merely the result of the investor behavior,
any stock price sequence contains the aspirations and prospect values of the investor
community. In fact, stock price sequence constitutes the only basis for our
calculation of the stock price prospect values. Insofar as this is concerned, the use of
mathematical expectancy methodology by the standard financial theories to calculate
stock price expected values is totally unscientific.
Patterns of the stock price movement
Movement in stock price can be divided into three patterns. The first is the
pattern of continuity, which can be divided into upward continuous pattern and
downward continuous pattern. These two patterns can be sub-divided into certain
types. Any combination of two types of upward continuous pattern will result in a
brief stock price increase trend, Any combination of any type of upward continuous
pattern and downward continuous pattern will result in a brief stock price sequence
with variations in increase and decrease.
The second type is non-continuous pattern. Such pattern takes the form of
continuous pattern being disrupted, and its quantity is simply too numerous to be
counted. The third type is the independent pattern, and can be divided into upward
independent pattern and downward independent pattern. Each independent pattern
can be further broken down into certain types of categories. The same type of the
same or different independent pattern occurs with great frequency. In stock price
sequence, we often see continuous skyrocketing or nose-diving, and these are
manifestations of the continuous occurrence of the same or different types
independent patterns.
Studies performed by the present author indicates that any stock price sequence
11

is comprised of the above three patterns of combinations of their constituents. The
three patterns and their types in identical or different combinations can yield
constantly changing combinations, and this is the root cause of why the movement in
stock price is so capricious. Although changes in stock price are evolving all the
time, the rules constituting the constraints of their movement are rather simple, and
the patterns and types of their movement are also limited. In the Dow J ones
Industrial Average daily closure figures spread over a period of 102 years (involving a
total of 28500 turnover figures), around 12000 days of turnover figures belong to the
continuous pattern, representing 42% of the total. Approximately 15000 days of
turnover figures belong to the non-continuous pattern representing 53% of the total.
About 1500 days of turnover figures belong to the independent pattern making up 5%
of the total.
Rules governing stock price movement
The stock price movement follows certain rules. Normally, a 5-year-long stock
price historical sequence with the transaction day as the time interval contains all the
patterns of the stock price movement. All the historical sequences of the stocks all
over the world are composed of the same kind of the patterns of the stock price
movement.
Movement in stock price boils down to the result of investor decisions. As
investor decision matches individual aspirations and logic, the patterns of stock price
movement certainly matches human aspirations and logic. As a result, patterns of
stock price movement must necessarily fit in with human aspirations and logic. As
human aspirations are knowable and human logic itself means the following of
prescribed rules, the stock price changes according to certain rules of the game.
However, only when we truly understand how investors make decisions is it possible
for us to understand the rules governing the stock price movement.
The rules governing stock price movement are different from the nature rules
such as the accurate automatic rotation of the earth within 24 hours for one round.
They are logical rules with multiple ways of expression. Through analysis of stock
price sequences, we are fully capable of analyzing logical rules governing stock price
movement, in the same way as the understanding of the meaning (logic) of a sentence
through its analysis.
To properly analyze the logic associated with the analysis of stock price
12

movement is by no means an easy task. And to beat the market by utilizing the logic
linked with the analysis of stock price movement is even more difficult. The stock
price movement logic is expressed in multiple forms in the same way as we use
different sentences to express the same meaning (logic). For this reason, unless you
really understand the ways of expression of the logic associated with all stock price
movement, it is impossible for you to be sure to be able to beat the market.
The above discussion has, in fact, not taken into account the impact of
fundamental factors, which, if taken into consideration, would enable us to see that
the logic of stock price movement is invariably interrupted by the said fundamental
factors. Let us make a comparison, when someone is in the middle of talking, he is
abruptly interrupted, and so the logic of his flow of thoughts is put to a halt.
Consequently, to prevent the logic of your stock price movement from being affected
by fundamental factors, you must, beforehand, perform analysis on all possible
fundamental factors. This would mean that, unless you are both an expert at logical
analysis of the stock price movement plus an expert at the analysis of fundamental
factors, it is just impossible for you to be sure to be able to accurately understand the
stock price movement logic and ultimately beat the market.
Stock price behavior in the absence of external information interference
Due to the presence of thousands of investors in the stock market, the investor
behavior of pursuing profits has made the stock price fully covered with layers of
investor decision systems on any one timing point. Such a market does not entail
any lasting profitable opportunities at all. As the stock price is the most important
criterion determining the predilection of the investor and it consists of three elements,
viz. direction of stock price movement, magnitude of the stock price movement and
stock price movement unit intervals, change of any one of the foregoing three
elements could result in numerous investors experiencing change in their expectation
values. Change in the investor expectation values will give rise to change in the
investors decision. And change in the investors decision will in turn lead to new
change in the stock price. In this cycle of price change change in investor
expectation values change in investor decision new change in the stock price, in
the absence of influence exerted by the external information, the stock price will keep
on changing with the sole investors ideal is taken on board.
13

2.3 Inter-relationship between the investor behavior and stock price
behavior
Only on the basis of having obtained a scientific understanding of the investor
behavior and stock price behavior is it possible for us to understand the
interrelationship between the investor behavior and stock price behavior. With
respect to the interrelationship between the investor behavior and stock price behavior,
the focus of our concern should be laid squarely on the way the investor interprets the
stock price sequences.
First of all, it is incumbent upon us to comprehend the way of the intrinsic
prospect values on the part of the investment communities conveyed and expressed by
the stock price sequences. Such prospect values are not expressed through one unit
time stock price from the stock price sequence, but through a group of the stock prices.
Although our vision system enables us to observe the stock price sequence over a
rather extended period of time on the surface, we cannot deduce the prospect values
embodied in the stock price historical sequences.
Second of all, to calculate the expected values of the stock price sequence, one of
the prerequisites is that we must obtain a scientific understanding of the relationship
between the stock price sequence, unit time stock price and the expected price (or
return).
The relationship between the real-life historical stock price sequence, unit time
stock price and the expected price (or return) is just like the relationship between a
sentence, word and the meaning of the sentence. The word is the basic element of a
sentence, and a sentence is normally composed of several or a dozen words. The
sequence of each word in a sentence is of crucial importance to a sentence. To
understand the complete meaning of a sentence, we must observe the meaning of each
and every single word. At the same time, we must observe the sequencing of the
words making up the sentence along with the involved internal logic. We cannot
decipher the meaning or the associated logic of the entire sentence from the meaning
of a single constituent word. If you change the sequencing of the words in the
sentence, the meaning of the sentence would be changed, because you have changed
the logic of the involved sentence.
When we embark on the analysis of the prospect values of a stock price sequence,
we must, concurrently, take the sequence order of the stock prices comprising the
14

stock price sequence and the basic elements of One unit time stock price, viz.
direction of stock price movement, magnitude of the stock price movement and stock
price movement unit intervals into consideration. This is because, if the sequencing
of the stock price experiences changes, the prospect values of this sequence change
accordingly; if we change any one element out of the foregoing three elements, the
prospect values associated with the stock price sequence experience change
accordingly. That is to say, change in the stock price sequencing or change in any
one of the three elements at a given time interval could lead to alteration in the stock
price sequence prospect values.
The stock price at a given unit time represents but one single reference point of
the prospect values of the stock price sequence, and, as such, does not possess any
independent logical connotations. In recognition of this, it is impossible for us to use
the stock price of a given time interval to fully reflect the prospect values contained
in a stock price sequence. In fact, it is merely impossible for us to derive the
prospect values of the stock price sequence involved from one unit time stock price.
Lastly, at the time of the formation of the future stock price expected value, the
investor has three kinds of different expectation values. As a result, we need a
sufficiently long stock price sequence instead of a single group of stock prices to form
accurate expectancy of the future of the stock price. On average, to scientifically
observe the movement of a certain stock over a certain transaction day, we must, at
least, examine the daily data for the involved stock over the past 5 years.
To integrate the above research conclusions regarding the investor behavior, the
stock price behavior, the interrelationship between the investor behavior and stock
price behavior along with a combination with the stock pricing formula drawn up by
the present author, we are in a position to pass brief judgment on whether Efficient
Market Theory is scientific or not. In the sections that follow, the present writer will
use the basic elements of this particular analysis framework as terms of reference to
carry out a detailed comparative analysis on the theoretical models of EMT and the
basic elements making up EMT.

15

3 A Historical Perspective on EMT
3.1 Pre-history Stage Of EMT (1900 1965)
EMT can be traced back to the French mathematician Louis Bacheliers thesis
(1900) entitled Theory of Speculation. In the paper, Louis Bachelier, for the first
time ever, assumes that changes of the stock price from transaction to transaction are
independent, identically distributed random variables. He asserts that speculation
should be a fair game and the expected profits to the speculator should be zero.
Louis Bacheliers research means that the current stock price presented an unbiased
estimation of the future stock price. Unfortunately, Bacheliers research did not
arouse much attention at the time. Over 50 years later, his above-mentioned paper
caught the attention of the economists.
In the 1930s, research on stock and futures prices mainly include Cowles (1933),
Working (1934) and Cowles (1944). Through the study of the main financial
services companies and investment media of the time, Cowles finds that the best
financial institutions investment records and the best individual forecasting records
failed to demonstrate that they exhibited skill, and indicated that those records more
probably were results of chance. Cowles therefore conjectures that these financial
institutions relied on luck instead of competence or anticipating techniques to acquire
investment and anticipate results. At the same time, Security Analysis by Graham
and Dodd (1934) and Theory of Investment Value by Williamsg 1938 have
influenced countless financial analysts and economists. The concepts of intrinsic
value, fundamental value, discounting outlined in these two books have played a
crucial role in shaping EMT.
The British statistician Kendall (1953) after examined the behavior of the weekly
changes in time sequences associated with the cotton, wheat futures price and stock
price indexes, declares in his paper that changes in the price sequences placed under
scrutiny are independent, the observed price changes in those time series seem to be
approximately normally distributed, there is no hope of being able to predict the
behavior of these price changes for a week ahead without extraneous information.
Roberts (1959) appeals that use should be made of Kendalls statistical approach in
studying the behavior of the stock price.
On the basis of Louis Bachelier, Osborne (1959) had carried out a major revision
16

on the research target: the percent change in the stock price is no longer the target of
research. In its place is the change in log price. For the first time ever, Osborne
specified that common stock prices can be regards as an ensemble of decisions in
statistical equilibrium, with properties quite analogous to ensemble of particles in
statistical mechanics. He declares that the investor evaluates the stock on the basis
of the expected return, and the expected return is the weighted average of the sum of
all possible rates of return. Research work carried out by Osborne represents a
major milestone in the development of EMT. Close on the heels of Osborne
research, Larson (1960), Working (1960), Houthakker (1961), Alexander (1961),
Cootner (1962), Moore (1962), Granger and Morgenstern (1963) in succession,
published their respective papers supporting the assumption that the stock price
follows a random walk.
The Random Character of Stock Market Price by Cootner (1964) is a
collection of a full batch of papers constituting the foundation of EMT. At the same
time, the theory of Portfolio Selection by Markowitz (1952) specifies why the
diversification of investments could reduce risk. The Capital Assets Pricing Model
by Sharpe (1964) proceeds on the basis of Markowitz to specify how investors would
go about their investment activities if they were rational.
The research paper by Fama (1965) concerning stock price behavior wrapped up
the research results of all of his predecessors concerning the random walk model, and
provides new theoretical evidence for the theory of random walk. That paper
highlights inconsistencies between the actually observed statistics of the behavior of
the stock price and the predictions of the theory of random walk. For instance, the
distribution of daily price changes in a speculative series is not approximately normal,
and changes in the stock price sequences are not fully independent etc. For the first
time ever, Fama (1965, p. 35) brings up the concept of efficient market and defines
that the independence assumption of the random walk model could be accepted as
long as the independence in the series of successive price changes is not above some
minimum acceptable level. More specifically,
The independence assumption is an adequate description of reality as long as
the actual degree of dependence in the series of price changes is not sufficient to allow
the past history of the series to be used to predict the future in a way which makes
expected profits greater than they would be under a nave buy-and-hold model.
Some findings of the same period also identify that the stock price movement is
17

inconsistent with the random walk model as in the cases of Houthakker (1957),(1961),
Osborne (1962), Larson (1960), Cootner (1962), Steiger (1964). But these findings
did not receive adequate attention from the academic circle. Alexande (1961) was
subjected to query. Cowles (1960, p. 914) discoveries that:
A positive first-order serial correlation in the first difference has been disclosed
for every stock price series analyzed in which the intervals between successive
observations are less than four years.
However, such important statistical analysis conclusions did not receive the level
of attention from the academic circle that they deserved due to suspicion that there
could be statistical anomaly and that there would be no economic return after
deduction of the involved transaction cost. Another noteworthy figure is Kendall
(1953, p. 20-21) who writes that:
We get greater serial correlation in the averages than in the constituent series,
which at first sight seems absurd and in any case is very misleadingWhatever the
reason, the existence of these serial correlation in average series is rather disturbing.
Fama (1965) also mentions the foregoing paragraph. However, such important
finding again did not merit adequate attention.
3.2 Formation And Refinement Stage Of EMT (1965 1991)
Mandelbrot (1966) gives Efficient Market Hypothesis, a rigorous probability
foundation and provides explanations on the stock price behavior from an economics
standpoint. To give a defined economic justification on the capricious stock price
behavior, Samuelson (1965) paper entitled proof that properly anticipated prices
fluctuate randomly provides the same sort of demonstration in his thesis in relation
to the Martingale models: in an information-efficient market, if the stock prices are
properly anticipated, their changes will certainly not be forecast. This particular
thesis by P. A. Samuelson concerning commodity futures price behavior is generally
regarded as a milestone for the formation of Efficient Market Hypothesis. From then
on, Martingale models have taken the place of the random walk model for economists
to describe the stock price behavior.
Robertsg 1967divides EMH into three categories, viz. weak form, semi-strong
form and strong form.
Fama (1970) has brought together all the research results of his predecessors to
form the eventual Efficient Market Hypothesis. Fama (1970, p. 383-416) asserts:
18

We shall contend that there is no important evidence against the hypothesis in
the weak and semi-strong form testsand only limited evidence against the
hypothesis in the strong form testsin short, the evidence in support of the efficient
markets model is extensive, and (somewhat uniquely in economics) contradictory
evidence is sparse.
In the mean time, Markowitzs Portfolio Selection theory, Sharpes Capital Asset
Pricing Model, Rosssg 1976APT and Black-Scholesg 1973Option Pricing Model
have jointly formed the theoretical framework of studying the capital markets. The
emergence of EMT has provided staunch theoretical support to the foregoing models.
As such expressions as fully reflect and all available information by Fama
(1970) are too vague, it is imperative to provide specification when actually applying
them to the practical stock market to ensure that they are operable. In addition,
Fama (1970) theoretical deduction process is somehow linked to intentional setting of
the logical framework. To accurately test the efficient market validity, especially the
feature of fully reflecting all available information, financial scholars have
conducted a large amount of research work in this regard.
A decade after Samuelsons (1965) landmark paper, many others extended his
framework to allow for risk-averse investors, yielding a neoclassical version of the
EMT (for example, LeRoy (1973), Rubinstein (1976) and Lucas (1978). Malkiel
g 1973best-seller A Random Walk Down Wall Street has made it possible for
more people to accept the EMT.
Fama (1976a) serves to strengthen and reinforced the definition of EMT in Fama
(1970). J ensen (1978, p. 1) provides a succinct and practical definition of EMT and
asserts that:
I believe there is no other proposition in economics which has more solid
empirical evidence supporting it than the Efficient Market Hypothesis.
Grossman and Stiglitz (1980) advance a paradox. Grossman and Stiglitz (1980,
p. 404-405) argue that perfect informational efficient market is impossible. In view
of the paradox presented by Grossman and Stiglitz (1980), especially some research
conclusions showing enormous amounts of transactions in the stock market and the
observation of the irrational behavior of investors, it is hard to see proper coordination
with the EMT. Black provides an answer: Noise causes markets to be somewhat
inefficient. Black (1986, p. 533) also supplies a definition of EMT as follows:
We might define an efficient market as one in which price is within a factor of 2
19

of values, i.e., the price is more than half of value and less than twice value.
From the development history of EMT over this period of time, we can see that
the research work carried out by some scholars has possibly changed the fate of EMT.
For example, Niederhoffer and Osborne (1966, p. 897) identifies that:
The accurate record of stock market ticker prices displays striking properties of
dependenceafter two prices changes in the same directions, the odds in favor of a
continuation in that direction are almost twice as great as after two changes in
opposite directions.
Although their findings aroused some attention, they did not exert any impact on
the formation of EMT. As far as Fama is concerned, the type of dependence
uncovered does not imply market inefficiency.
Shiller (1981) research conclusion dealing with stock price volatility poses a
challenge of historic significance on EMT. DeBondt and Thaler (1985) took issue
with the correctness of EMT. The real heavy blow to EMT is the stock market crash
of 1987. From October 13 through October 19 of 1987, DJ IA falls from 2508 to
1739 with the stock price index witnessing a drop of nearly 31% within 4 full trading
days, which represent about 1 thousand billion US$ loss of all the US stocks.
Economists commented that there did not exist any tangible factor leading to 30%
fluctuations on the stock price.
9
Confronted with the above crude reality, EMT
theorists have had no alternative but maintain silence.
For some investors such as Warren Buffet, J ohn Templeton, J ohn Neff, Paul
Tudor J onesL , beating the market over the long-term is clearly contradictory with the
EMT. Samuelson (1989, p. 4-5) argues:
Those lucky money managers who happen in any period to beat the
comprehensive averages in total return seem primarily to have been merely
luckybroadly speaking, the case for efficient markets is a bit stronger in 1989 than
it was in 1974
However, for the first timeo he admits that:
On the whole, I side with Shiller and Modigliani and am prepared to doubt
Macro Market Efficiency.
Confronted with a large amount of evidence contradictory to EMT stemming
from theoretical study and empirical research, Fama (1991) makes major revisions on

9
Samuelson, Paul A. and Nordhaus, W., 1998, Economics, Chinese edition, Hua Xia Publishing House. See p.
395, comment by the Nobel laureate economist J ames Tobin of Yale University: to the effect that there does not
exist any tangible factors could cause stock value to change by 30%.
20

the definition of EMT and the descriptions of the three forms of the EMT. In view
of the paradox of Grossman and Stiglitz (1980), Fama (1991) lists a number of
prerequisites in support of the establishment of EMT.
He further incorporates J ensen (1978) definition into EMT. At the same time,
Fama (1991) revamps the weak-form test under Fama (1970) to tests for return
predictabilityo and changes semi-strong test into event studies, and strong-form test
into test for private information. Fama (1991, p. 1577) writes:
The empirical literature on efficiency and assert-pricing models passes the acid
test of scientific usefulness. It has changed our views about the behavior of returns,
across securities and time...the empirical work on market efficiency and assert-pricing
models has also changed the views and practices of market professionals.
To this point, revisions and refinement of EMT drew to a conclusion.
3.3 EMT At the Stage Of Decline ( 1991 Present)
With the emergence of a large number of Anomalies in the 1980s stock
market, CAPM could no longer provide rational explanations on them. Fama (1992),
(1993), (1996) abandoned his support for CAPM which he had adhered to for over
two decades. By that point, when mentioning market efficiency, economists no
longer referred to fundamental value efficiency and informational efficiency together.
They were, in fact, making references to informational efficiency.
In the 1990s, Behavioral Finance began to emerge in the financial academic
circle. Important research papers of this period include the following: J egadeesh and
Titman (1993), Lakonishok, Shleifer, and Vishny (1994), Shleifer and Vishny (1997)o
Barberis, Shleifer, and Wishny (1998), Hirshleifer, and Subramanyam (1998).
Lo and Mackinlay (1999) argue that the random walk hypothesis can be rejected.
Shiller (2000) gives a detailed analysis the behavior factors that lead to investment
bubbles. He argues that stock prices are to some extent predictable and that efficient
market hypothesis should be rejected.
In the face of the wave-like challenges to the EMT, Fama (1998, p. 284) writes:
It is time, however, to ask whether this literature, viewed as a whole, suggests
that efficiency should be discarded, my answer is a solid no.
He reiterates yet again:
Like all models, market efficiency (the hypothesis that prices fully reflect
available information) is a faulty description of price formation. But following the
21

standard scientific rule, market efficiency can only be replaced by a better specific
model of price formation, itself potentially rejected by empirical tests.
He further warns his opponents:
Any alternative model has a daunting task. It must specify biases in formation
processing that causes the same investors to under-react to some types of events and
over-react to others. The alternative must also explain the range of observed results
better than the simple market efficiency story.
The real lethal blow to EMT came when the irrational exuberance and the
Internet Stock Price Bubble emerged in the United States stock markets in the late
1990s. To make matters worse, one of the main proponents of EMT, Paul A.
Samuelson issued a statement through his personal correspondence to the effect that
the stock market is Micro Efficient but Macro Inefficiency. According to J ung
and Shiller (2002, p. 3), Samuelson argues:
Modern markets show considerable micro efficiency (for the reason that the
minority who spot aberrations from micro efficiency can make money form those
occurrences and, in doing so, they tend to wipe out any persistent inefficiency). In
no contradiction to the previous sentence, I had hypothesized considerable macro
inefficiency, in the sense of long waves in the time series of aggregation indexes of
security prices below and above various definitions of fundamental values.
Over the past 5 years, reports which continue to defend the EMT include
Rubinstein (2001), Schwert (2003), Malkiel (2003) and (2005). Although CAPM is
no longer held in high esteem, EMT has also somehow reached a dead end.
However, it should be noted that the hot Behavioral Finance also contains its own
inherent drawbacks, and cannot replace EMT as the new core of financial theories.
Currently, some scholars have already embarked on the coordination of EMT with
Behavioral Finance, such as Lo (2004) and (2005). Some scholars have proposed
New Finance as in the case of Haugen (1995) and (2003), Stout (2005). In addition,
some scholars are relatively pessimistic, such as Barberis and Thaler (2003, p. 61)
concludes:
We have two predictions about the outcome of direct tests of the assumptions of
economic models. First, we will find that most of our current theories, both rational
and behavioral, are wrong. Second, substantially better theories will emerge.

22

4 Analysis of Errors with The Theory of Random Walk
It can be clearly seen from the history of development of EMT that the theory of
random walk essentially represents the pioneering empirical study of EMT. From
this perspective, EMT is the theory of random walk duly tempered and rationalized by
the principles of economics. Although EMT does not necessarily mean that stock
price changes follow a random walk, if the stock price movement follows a random
walk, it follows that the market is efficient. According to Fama (1965, p. 34-35), the
random walk theory can be recaptured as follows:
The theory of random walk says the future path of the price level of a security is
no more predictable than the path of a series of cumulated random numbers. In
statistical terms the theory says that successive price changes are independent,
identically distributed random variables. Most simply this implies that the series of
price changes has no memory, that is, the past cannot be used to predict the future in
any meaningful wayThe theory of random walks in stock prices actually involves
two separate hypothesis: (1) successive price changes are independent, and (2) the
price changes confirm to some probability distribution
Fama (1965, p. 90-98) conclusion concerning the random walk theory:
The independence assumption of the random-walk model seems to be an
adequate description of realityit seems safe to say that this paper has presented
strong and voluminous evidence in favor of the random-walk hypothesis
Research performed by the present author indicates that Fama (1965) research
conclusions are entirely wrong. Errors with the random walk theory also include
cognitive errors and mistaken research methodology.
4.1 Mistakes with perception
First of all, the theorists of random walk wrongly judge the nature of the stock
price behavior.
The only similarity between a real-life stock price sequence and a random time
sequence is that they change with the passage of time.
In the random time sequences of turning gear, throwing dice and random card
dealing along with particle movement in the micro world, past, present and future do
not have any particular meaning. As any one of the historical sequences of the stock
price embodies human aspirations, it enables the historical sequences of the stock
23

price to contain the time arrow aimed at the future.
In addition, the stock price movement sequences also contain the prospect values
of the investment community. Such intrinsic prospect values are not expressed
through one unit time stock price from the stock price sequence, but through a group
of the stock prices. Consequently, the random walk model assumes that successive
changes of the stock price are mutually independent is simply not fit for describing
the stock price sequences.
Because of the reason that any random time sequences or emulation stock price
sequences cannot embody the two elements of the investor prospect values and
investor community collective aspirations. Consequently, any random time
sequences or emulation stock price sequences is not fit for describing or
approximating the stock price historical sequences. This means that any models
describing the random time sequences or emulation stock price sequences are not fit
for describing the real-life stock price sequences. But in the eyes of the scholars of
the time, the historical price sequence behavior on the part of a particular stock is no
different from that of the random time sequence of throwing dices and dealing cards
or molecular particles movement in the micro world.
Second of all, the theorists of random walk wrongly judge the very nature of the
stock market.
On the surface, the stock price behavior appears to be determined by the
capricious psyche of the market. To the mind of the random walk theorists, stock
price movement is very much like the footprints left behind by a drunkard with no
logic to speak of. In other words, stock price movement is comparable to the digits
of the gambling table with no memory capacity at all. In recognition of this, stock
price movement follows no defined rules. Stock market is akin to a gambling house.
But, in actual fact, stock market is not a gambling house. Rather, it is the venue
where investors harbor their dreams and aspirations. The rising trend in the stock
market price points to the same ideal direction of the investors. It goes without
saying that the stock market is not a balanced static market. Rather, it is a dynamic
market that is constantly evolving towards the direction of hope and aspirations for
the investors. The ideal market is not an assumed or virtual one. It is the ultimate
objective of present stock market.

24

4.2 Erroneous research methodology
The theorists of random walk have chosen the wrong research direction and
inappropriate research target analysis of the stock price behavior from probability
distribution angle boils down to statistical behavior of the stock price. Percent
changes of the stock price or changes in log price of the stocks become the research
object.
Irrespective of Bachiler, Osborne or Fama, they are all engaged only in studying
the statistical behavior of the stock price to the total neglect of the three principal
elements, viz. direction of the stock price movement (rise and fall), the magnitude of
the stock price movement and the unit time of the stock price movement. This has
not come about abruptly, and should be attributed to the fact that, irrespective of
Bachiler or the contemporary scholars, they all hope to be able to formulate a full set
of mathematical statistical models to accurately capture the speculative price
behavior.
And standard statistical techniques are the tools with which to make the
foregoing dreams come true. However, in order to apply the standard statistical
techniques to the analysis of the behavior of the time sequence of the stock price,
people must assume that the behavior of the time sequence of the stock price has the
same statistical nature as the behavior of a random time sequence. That is because
the target of such standard statistical techniques must be independent and identically
distributed variables. If the successive price changes are independent, and
identically distributed variables, then when the amount of the stock price sequence is
big enough, the Central-Limit theory will leads us to expect that price changes will
have normal distributions.
Substantial studies carried out in the 1960s demonstrate that stock price
statistical behavior is inconsistent with the scholars assumptions. Such studies
demonstrate that price changes do not conform to normal distributions. If the stock
rate of return is not normally distributed or approximation to normal distribution,
standard statistical analysis tools, such as serial correlation analysis, will give
misleading answers. Scholars assume that the stock price follows a random walk,
25

and such assertion is very much in doubt.
Since two reasons have created the situation whereby the statistical behavior of
the stock price and the stock rate of return are not fit for the research direction and
target.
First, The overwhelming majority of the people (with the notable exception of a
very small minority who have received very good professional training) are not used
to conduct their thinking on the basis of probabilistic distribution. The human brains
are not used to calculation on the basis of percentile figures. The overwhelming
majority of the people will have the mistaken impressions, viz. stock price movement
sequences are of the same statistical nature as the gambler games in terms of random
time sequence.
Second, Each and every investor only focuses his attention on the stock price
point. And the stock market is concerned about the price zone of the entire stock
market. From an analysis technique point of view, we can use stock price point and
stock price zone as a combination for calculating the expected stock price. But it is
very hard, if not impossible, for us to set a sort of reasonable zone for the rate of
return of the stock price, and then integrate it into the calculation of the expected
return. Even if we preset a reasonable zone for the stock rate of return, that would
result in misguided conclusions of the standard statistical tests of the data.
Based on the above conclusions, we can say with certainty that, in analyzing the
stock price statistical behavior, by using the standard statistical analysis tools, we will
be able to arrive at the misguided conclusions. For instance, when we use run
tests
10
to test dependence of the stock rate of return, the results would be major
deviations or totally misguided conclusions. In actual reality, Fama (1965), (1966)
mentions such run tests maybe resulting in mistaken conclusions on two occasions.
Specifically, Fama (1965, p. 80) writes:
There are situations in which they do not provide an adequate test of either
practical or statistical dependencethe run tests are much too rigid in their approach
to determining the duration of an upward and downward movements in prices. In
particular, a run is terminated whenever there is a change in sign in the sequence of
prices changes, regardless of the size of the price changes that causes the change of
the signit is possible, however, that price changes are dependent only in special
conditions.

10
According to Fama (1965): A run is defined as a sequence of price changes of the same sign.
26

4.3 Root cause analysis
The main reason contributing to errors with the random walk theory is that the
theorists simply lacked systematic study of the actual investor behavior.
For instance, According to Campbell, Lo and Mackinlay (1997), the simplest
random walk model can be written as the following equation:

t
t t P P + + = 1 , , (1) ) , 0 ( ~
2
IID
t
(Where is the expected price changes or drift, and denotes that ) , 0 ( ~
2
IID
t
t
is independently and identically distributed with mean 0 and variance .)
2

Based on the research conclusions of the present author in Section 2 of the

present paper:s
First of all, the stock price sequences contain the ideal of the investor and
prospect values of the investment community. Such prospect values are not
expressed through one unit time stock price of the stock price sequence, but through a
group of the stock prices.
Second of all, The stock price at a given unit time represents but one single
reference point of the prospect values of the stock price sequence, and, as such, does
not possess any independent logical connotations. In recognition of this, it is
impossible for us to use the stock price of a given time interval to fully reflect the
prospect values contained in a stock price sequence. In fact, it is merely impossible
for us to derive the prospect values of the stock price sequence involved from one unit
time interval stock price.
Based on a comparative study of the foregoing two points and the random walk
model, we can easily make our judgment on whether the random walk model can be
used to describe the stock price behavior. The conclusion is crystal clear: the
random walk model is simply unfit for use in describing the stock price behavior.
The reason is that: the random walk model simply cannot scientifically reflect the
investor aspirations and prospect values as embodied in the stock price sequences (the
investor simply cannot rely on the random walk model to correctly calculate the
expected value of the stock price sequence). The random walk model simply cannot
reflect the rules governing the stock price movement. It cannot scientifically
recapture the inter-relationship between the investor behavior and stock price behavior.
27

In actual fact, to use the random walk model to describe the real-life stock price
behavior is akin to asking an illiterate to read poetry, which is certainly absurd to the
extreme.

5 Analysis on Errors with EMT
Kendall (1953) conclusions mean that the stock market is predisposed by
unstable market psyche without following any set rules. However, the financial
economists could not accept the irrationality characterization implied in Kendalls
conclusions. Through consistent efforts over more than a decade, economists and
financial scholars at long last succeeded in creating EMT. EMT provides a
brand-new footnote to Kendalls conclusions. EMT states: stock price random
change does not mean the irrationality of the stock market itself, on the contrary, that
is the natural outcome of the numerous rational investors vying with one another in
making use of the information to gain profits from the stock market. EMT attributes
the stock price behavior looking like a random walk to the competition of countless
rational investors in the stock market.
Unfortunately, the stock price movement resembles a random walk is only
spurious. That is to say, Kendall and the random walk theorists conclusions are
mistaken. EMT theorists have never expected Kendall and the random walk
theorists conclusions could be mistaken. Moreover, it has not occurred to the EMT
theorists that, due to lack of systematic and scientific study of the actual investor
behavior on the part of the economists, some general concepts and principles
applicable to economics are simply not fit for use in analyzing the stock price
behavior. In actual facto EMT theorists engage themselves in giving a defined
economic justification on the mistaken research conclusions of the random walk
theorists with the improper economic equilibrium framework. Precisely for this
reason, EMT and the random walk theory are both mistaken.
5.1 Absurdities with the efficient market definition
According to Fama (1970, p. 383), the efficient market is defined as follows:
28

That security prices at any time fully reflect all available information. A
market in which prices always fully reflect available information is called
efficient.
The definition of efficient market in succinct terms as that the stock price, at any
given unit time, fully reflects all available information. In Section 2, the present
paper has already stated that,
Firstly, as any one stock price sequence contains investor aspirations and investor
prospect values, any one stock price sequence should be seen as a source of generic
information, the stock price at any one given unit time is a part of this sort of
information in its own right.
Secondly, the stock price at a given unit time represents but one single reference
point of the prospect values of the stock price sequence, and, as such, does not possess
any independent logical connotations. In recognition of this, it is impossible for us
to use the stock price of a given time interval to fully reflect the prospect values
contained in one stock price sequence.
Lastly, at the time of the formation of the future stock price expected value, the
investor has three kinds of different expectation values as mentioned in Section 2 of
the present paper. But EMH assumes that the investor relies on mathematical
expectation to form expectations of the future stock price.
Integration of the above three points and comparing it with the definition of
efficient market by Fama (1970), we can clearly ascertain that the definition of
efficient market is rather absurd.
The root reasons account for the absurdities of the efficient market definition are
that: EMT theorists simply lack scientific understanding of the inter-relationship
between the investor behavior and stock price behavior.
(i) From the development history of EMT, we can see that EMT theorists have
simply carried forward the majority of the mistaken beliefs and perceptions of the
random walk theory concerning the stock price behavior. Irrespective of the random
walk theorists or EMT theorists, stock price is but a random variant with no special
connotations. In the stock market depicted by EMT, the relationship between the
historical stock price sequence and the information acts like that represented in the
best-selling Investing Money
11
by N. Danbar, as follows: as the investors absorb
information like armies of ants devour the black bear in the woods, and the stock price

11
Dunbar, N., 2002, The story of Long-term Capital Management and the Legends behind it, (First edition of
Chinese version), Shanghai, Peoples Press. P. R. of China. See p. 22. Quotation.
29

is very much like the skeleton consumed to the extreme. Consequently, the history
sequence of the stock price is of no use to predict the future path of the stock price.
(ii) On the key question of the investor behavior, EMT theorists have been
unable to conduct any systematic and scientific study on the actual investor behavior.
What they have done has been to pick a hypothetical rational investor from the
framework of economics analysis, and then use the assumed rational investor to
replace the real-life investor. The consequence of such unscientific practice is that
EMT theorists simply cannot scientifically acknowledge and explain the
inter-relationship between the investor behavior and stock price behavior.
Unfortunately, the key to this question lies in that, to scientifically describe the
relationship between the stock price behavior and external information, the
precondition is that we could scientifically explain the interrelationship between the
investor behavior and stock price behavior. From the background information, we
can see that it has already taken theorists over 30 years to look for the right sort of
stock price behavior to ascertain the matching of efficient market definition with
actual stock price movement. They have not succeeded to date, however.
5.2 Unscientific theoretical models
As a result of the creative studies performed by Samuelson (1965) and (1973),
Mandelbrot (1966) and Fama (1970), Martingale models have replaced the random
walk model to become the approximate model adopted by economists to describe the
stock price behavior. Consequently, the EMT theorists closely combined the EMT
with the Martingale models. In actual application, validations of the Martingale
models are tantamount to validation of the EMT. Because of the theoretical studies
of LeRoy (1973), Lucas (1978) and empirical studies of Shiller (1979), (1981b) and
LeRoy (1981) on EMTo it dawned on the financial theorists that there is no inherent
linkage between martingale models and market efficiency, and that it is just a
convenient but imprecise way to say that market efficiency means that stock price
follows the Martingales.
12

In this section, the present writer will scrutinize the EMT models listed by Fama

12
The Martingale model means that the actual volatility in the stock price should not be excessive; the stock price
itself, without the cumulative dividends added in, does not follow the Martingale model. In addition, we need to
assume such factors as the investor being risk-neutral etc. So it is difficult to reconcile EMT with the Martingale
model. For details, please refer to LeRoy (1989).
30

g 1970along with a model which economists used to test Efficient Market Theory.
In addition, the present writer will carry out a simple analysis on the assumptions
constituting the basis for the foregoing models.
Fair Game model
[ ] jt t t j t t j p r E p E )
~
( 1 )
~
( 1 , 1 , + = + +
(2)
First of all, the stock price at a given unit time represents but one single reference
point of the prospect values of the stock price sequence, and, as such, does not possess
any independent logical connotations. In recognition of this, it is impossible for us
to use the stock price of a given unit time interval to fully reflect the prospect values
contained in one stock price sequence. In fact, it is merely impossible for us to
derive the prospect values of the stock price sequence involved from one unit time
interval stock price.
Second of all, in forming his expectations of the future stock price, the investor
invariably has three kinds of expected values. In real-life situations, the real
individual investor does not rely on mathematical expectation at all to calculate the
stock price index expected return or individual stock expected return.
Lastly, please note that, in the Fair Game model, the information set stands
for all available information (including all the information concerning the historical
stock prices). As a result, we can see that, if Fair Game model can perfectly
recapture the stock price behavior, or act as a good approximation of the stock price
behavior, we simply cannot integrate with the information set .
t

) (
1 , + t j
P E
t

From the above cause analysis, we can clearly see that the left side of the
formula
)
~
( 1 , t t j p E +
is obviously absurd. The right side of the formula
[ )]
~
( 1 , t t j r E +
is also absurd for the same reason. Consequently, the Fair Game
model

[ ] jt t t j t t j p r E p E )
~
( 1 )
~
( 1 , 1 , + = + +

is not fit for describing the stock price behavior. Nor is it fit for describing the
interrelationship between the investor behavior and stock price behavior.
31

The Martingale models
jt t t j
p p E =
+
)
~
(
1 ,
and
jt t t j
p p E >
+
)
~
(
1 ,

(3)
Due to the same reasons as illustrated above, the Martingale and Sub-Martingale
Models are also not suited to be used to describe the stock price behavior.
In light of the brief history of EMT, we can see that, because of Samuelson
(1965), Martingale models have replaced the random walk model as the theoretical
models of EMT. Additionally, because of Samuelson (1973), Martingale models are
regarded as equivalent to the expected present-value model. Regrettably, due to the
following three reasons, irrespective of Samuelson (1965) or Samuelson (1973), the
conclusions are, without exception, unscientific.
(i) To construct a stock price behavior model, we have to describe the investor
behavior. The reason is that the stock price behavior is but the outcome of the
investor behavior. Should we fail to scientifically describe the investor behavior, it
would be impossible for us to construct a scientific stock price behavior model. In
section 2, the present paper has already listed out the basic elements required of the
investor to scientifically describe the investor behavior. If these elements are
compared against the investor behavior assumed by Samuelson (1965) and Samuelson
(1973), we can easily find out that, irrespective of the investor behavior assumed by
Samuelson (1965) or Samuelson (1973), they are totally absurd descriptions of the
actual investors behavior.
(ii) The expected-present-value model itself is not a scientific one. It is
unscientific because it wrongly regards discounting
13
as the basic approach which
investor uses in predicting the future stock price. In Section 2, the present paper has
already stated that the investor relies on three basic approaches in anticipating the
future stock price behavior. In reality, discounting is not a basic approach used by
the investor to predict the future stock price in any way. It is only an empirical
methodology derived from the foregoing three approaches. Special attention should
be made of the fact that discounting approach should not be used separately from

13
In the Malkiels famous book A Random Walk down the Wall Street, Malkiel, one of the outstanding advocates
of EMT has provided an objective and accurate description of the concept of discounting drawn up by Williams.
32

the three basic modes of investor expectations in the stock market. Although
discounting as an approach is widely used in the pricing of bonds, it would be
entirely wrong to use it as a basic approach for pricing the price of stocks. The
reason is pure and simple: fundamentally speaking, stocks and bonds are of entirely
different nature.
14
In addition, the process of stock price formation is totally
different from that of the bonds.
(iii) The definition of investor being risk-neutral is far from scientific. It is
well known to all that such definition exerts direct bearing on the modes of
expectation of the future on the part of the investor. As the standard financial
theories assume that the investor relies upon mathematical expectation to calculate
future returns, such critical assumption is totally inconsistent with the patterns of
anticipation of the future on the part of the actual investor. Consequently, definition
of the attitude towards risks on the part of the investor, such as risk neutral or
risk-averse etc. do not really possesses any scientific content. In other words, the
definition of being risk neutral or risk-averse on the part of the investor is actually an
unscientific description of the actual risk neutral or risk-averse attitudes on the part of
the investor.
If economists proceed from the Samuelson (1965) and (1973) research to rewrite
the EMT model as a model relates the current stock price to its expected present value,
and use it to validate EMT, economists will inevitably reach unscientific conclusions,
as in the case of Shiller (1981b).
15
The reason is as follows:
Firstly, martingale models are not at all fit for use in describing the stock price
behavior. Secondly, Samuelson (1965) and (1973) research conclusions are
unscientific. Lastly, The expected-present-value model is itself unscientific. We
cannot expect to have the model based on the integration of the above three
unscientific elements to bring about really scientific conclusions for us.
In addition, as there is no inherent linkage between EMT and the Martingale
models, it is impossible for us to pass any correct judgment on whether EMT is
scientific or not by merely relying on Martingale models or on empirical validation
conclusions on the foregoing model.
To sum up the analysis conclusions of the above fair game model and Martingale
models, we can see that, irrespective of Martingale models or fair game model, they

14
Due to limitation of the subject matter and space, it is impossible to dwell on the vastly different subjects of
stocks and bonds in this context.
15
Shiller (1981b) had used this particular model to validate the EMT, his research conclusions had not been
accepted by EMT theorists.
33

simply cannot scientifically describe and explain the interrelationship between the
actual investor behavior and stock price behavior. Consequently, irrespective of
Samuelson (1965), Mandelbrot (1966) or Fama (1970) theoretical models, they are all
not appropriate for use in describing the stock price behavior.
5.3 Assumptions and Theoretical Basis for EMT
Hypothetical conditions for EMT
Martingale Models and Fair Game model could be feasible in the ideal world of
EMT theorists for the reason that these models are predicated on a series of
assumptions that simply could not stand in real-life situations. The importance of
such series of assumptions is akin to the role of the wand to the magician during a
typical performance.
Samuelson (1965) conclusion is dependent upon the following major
assumptions: the rate of return associated with the stock is a random variant, the
investor thinks on the basis of probability distribution, and the investor anticipates the
expected price on the basis of mathematical expectations. The investors are
risk-neutral, etc.
Mandelbrot (1966) conclusion is depend upon the following core assumption:
stock price or rate of return is a random variant, stock market price movement evolves
around the intrinsic value, viz. the stock has its own unique intrinsic value. The
investor uses mathematic expectations to predict future stock price.
Fama (1970, p. 384-387) assumes that:
The conditions of market equilibrium can (somehow) be stated in terms of
expected returns(i) the conditions of market equilibrium can be stated in terms of
expected returns, and (ii) the information
t

is fully utilized by the market in forming

equilibrium expected returns and thus current prices, (iii) all agree on the
implications of current information for current price and distributions of future prices
of each security.
The above series of unrealistic hypothetical conditions are totally inconsistent
with the actual investor behavior and stock price behavior. The key to this question
lies in: the EMT theorists claimed that the real-life stock market is the efficient market
which consistent with Fama (1970) classical definition. That is to say, EMT could
best capture the behavior of the real-life stock market. In other words, EMT is a
34

good approximation of real-life stock market realities. As far as the EMT theorists
are concerned, EMT existence in the idealized world is reliant upon a series of
unrealistic assumed conditions with no impact on the practicability of EMT models in
the actual stock market. But the fact is: the above series of unrealistic hypothetical
conditions have excluded those basic elements concerning the real-life investor
behavior and stock price behavior which are essential to the establishment of a
scientific financial theoretical model.
Unrealistic theoretical foundations
16
EMT theoretical foundations are built on three hypotheses. First of all,
investors are rational investors. Secondly, as irrational investors transactions are
conducted in a random manner, their irrationalities will offset each other with the
result that the stock price will not be affected in any way. Thirdly, the rational
investor will arbitrage away the irrational investors influences to the stock price. As
the present author intends to dwell on the rational investor and arbitrage activities at
considerable length in the following section, we are focusing our attention on only the
second assumption in the present section.
First and foremost, as EMT theorists do not really understand the actual investor
rationality (this will be dealt with in the next section), it is impossible for them to
provide a scientific definition on the actual investor rationality. As a result, theorists
have no alternative but to assign a hypothetical definition to the investor rationality.
Unfortunately, such definition is totally inconsistent with the actual investor
rationality. In real-life stock market, we simply cannot find the rational investor
claimed by the theorists and nor is it possible for us to identify the so-called irrational
investor.
Secondly, to examine the impact on the stock price exerted by the investor
behavior, we must obtain a scientific understanding of how stock are priced in the
stock market. To this end, the precondition is that we must carry out scientific
descriptions of the actual investor behavior and stock price behavior. Unfortunately,
irrespective of the random walk theorists or EMT theorists, they simply find it
impossible to provide any scientific description of the real-life investor behavior and
stock price behavior. Consequently, theorists simply cannot understand how the
stock is priced in the actual stock market. To cope with the challenge on their

16
The present writer just follow Schleifer (2000) to comment on the theoretical foundations of EMT.
35

theories coming from the realities of the stock market, it becomes highly
understandable why the theorists have divided the investors into rational and irrational
investors in the market.
Obviously, the above assumption is fully inconsistent with the stock market
reality.
5.4 Other mistakes
The three forms of EMT
According to Fama (1970), EMT is divisible into three forms, namely, Weak
Form, Semi-Strong Form and Strong Form. The information set has three
meanings: the first meaning refers to all the available information relating to the past
history of the stock price. The second refers to all the information available to the
general public (including all the information relating to the historical prices of the
stock). The third refers to all the information available to the general public and
non-public (including all the information relating to the historical prices of the stock).
From the analyses performed earlier, we can see that when the information set
connotes all the information relevant to the historical prices of the involved stock,
EMT models simply cannot be correct. Therefore, irrespective of weak form,
semi-strong form or strong form, EMT is simply incorrect in whatever form. The
reason is that the meaning of the information set
t

associated with the three forms

of EMT at least refers to ALL the information related to the historical prices of the
stock involved.
Extended versions of EMT models and Market Efficiency
The underlying root causes why EMT theoretical models cannot scientifically
describe the investor behavior, and explain the interrelationship between the investor
behavior and stock price behavior lies in: the entire analysis framework of EMT is
unscientific, and the basic elements used by theorists in constructing EMT do not
possess scientific contents. Consequently, economists have but carried out revisions
to some relevant assumptions or have somehow integrated other expectation models
into EMT models. Such attempts are changes in form instead of substance and
would simply serve no purpose, as in the cases of Fama (1976a) or LeRoy (1973) and
Lucas (1978).
As the definition, theoretical models, theoretical foundations and the entire
analysis framework of the efficient market theory are unscientific, Some scholars
36

have, on the basis of Fama (1970), carried out further precise explanations and
expositions on the crucial part of the definition of efficient market as always fully
reflecting all available information, as in the cases of Rubinstein (1975), Beaver
(1979), Gilson and Kraakman (1984), only to no avail. The research conclusions
arising from such deductions such as the so-called informational efficiency and
fundamental value efficiency simply have no practical value at all.


6 Analysis of Basic Elements Constituting EMT
17
From the analyses conducted in the foregoing two sections, we can see that both
the random walk model and the Martingale models are unscientific stock price
models. However, these models are unscientific alone cannot justify that EMT is
unscientific. The reason is that, in actual applications in the pioneering days,
testing the Martingale models is equal to testing the market efficiency. Later on,
financial scholars realize that the assumption that stock price follows the Martingale
models is just a convenient assumption of market efficiency. In other words,
market efficiency does not necessary mean that stock price follows the Martingales.
According to LeRoy (1989, p. 1613):
The central idea of efficient capital market theory is that securities prices are
determined by the interaction of self-interested rational agents. At this most basic
level, the assertion that capital markets are efficient therefore reduces to the assertion
that it is economic theory rather than any other discipline that provides the analytical
tools appropriate for understanding securities pricing.
As a result, to ascertain whether EMT is scientific or not, we have no
alternative but to perform a brief analysis on some basic elements upon which the
economists rely in constructing EMT.
The conclusion of such comparative analysis demonstrates that, although these
basic elements directly describe the investor expectations and rationality or are
directly linked to the investor expectations and rationality, it is unfortunate that such
basic elements do not stem from the scientific induction of the actual human

17
Under normal circumstances, we should only examine one theoretical models connotations or deductions instead
of evaluating the entire fundamental assumptions associated with the theoretical model. EMT, as discussed in
Section of EMTs brief history, has been designed in a way that it is impossible to test whether it is scientific or not.
This certainly has been the only alternative available under the circumstance.
37

behavior observable by economists. They arise from unrealistic assumptions on the
part of the economists or from the general deduction of the assumed human behavior.
These basic elements do not possess scientific content. As a result, when
economists forcibly structure them into an economic analysis framework to describe
the interrelationship between the actual investor behavior and stock price behavior,
the conclusion drawn in this regard can only be one-sided or even entirely wrong.
Apparently, these basic elements cannot assist us to scientifically analyze and
understand the actual stock price behavior. Nor are they fit for describing the
interrelationship between the investor behavior and stock price behavior. Because
of the above reasons, EMT founded upon these unscientific basic elements can never
be a close approximation of the stock market realities.
The basic elements constituting the analysis framework used by the economists
in constructing EMT include: the Theory of Rational Expectations, rational investor,
arbitrage and equilibrium.
6.1 The Theory of Rational Expectations
Expectation
Expectation is a concept of crucial importance in the financial theory. The
majority of the elements used by economists to formulate EMT are associated with
this particular concept. For instance, Rational Expectations Hypothesis, rationality,
equilibrium, arbitrage, mathematical expectation, intrinsic value, expected utility,
risk-neutral and so on and so forth. Consequently, whether EMT can scientifically
describe the way which the actual investor forms his expectations of the future stock
price, becomes the key factor which decides whether EMT is scientific or not.
In the 17
th
century, mathematicians have managed to invent the mathematical
formula to calculate the expected value. Bachelier (1900) used such formula to
calculate the expected value of the French government bonds, and came up with the
conclusion that the expected return to the speculator should be zero. But Bachelier
had not probed whether such practice is scientific or not. Partly because of the
research work performed by Leonard J . Savage
18
whereby mathematical expectation is
thought fit for use in rationally calculating the expected value of the stock price.
Today, a majority of financial scholars still rely on mathematical expectation in

18
See Savage (1954), Friedman and Savage (1948).
38

calculating the expected return of the stock price. To quote the comment by famous
financial economists in their teaching material, the situation is that we do not have a
better method of measurement other than it.
19
From the development history of the theory of expectation, it can roughly be
broken down into the following categories: static expectation, Keynes expectation
theory, adaptive expectation theory, the Theory of Rational Expectations and Prospect
Theory.
20
In this particular context, due to limitation of space and relevance to the
main points of discussion, the present writer will limit our discussion to Keynes
expectation theory and the Theory of Rational Expectations.
Keynes expectation theory
Studies of Keynes expectation theory performed by the present author indicate
that, in Chapters 5 and 12 of The General Theory Of Employment Interest and
Money, Keynes provides a highly scientific and accurate description of investor
expectation. First of all, Keynes correctly points out that the actual investor
expectations can be divided into two forms, viz. short-term expectation and
long-term expectation. Secondly, Keynes correctly points out that the investors
short-term expectation (short-term expected value) is knowable. He further
incisively points out the mutual relationship between the pattern of the actual
investors expectations of the future stock price and the investor rationality. More
importantly, Keynes displays unique genius to scientifically demonstrate the
interrelationship between the actual investors expectations, decision-making and
confidence.
In addition, in this particular book, Keynes further correctly points out, in a
forward-looking manner, that it was rather unwise to rely on mathematical
expectation to describe the actual investors expectations and decision-taking aspects:
We are merely reminding ourselves that human decisions affecting the future,
whether personal or political or economic. Cannot depend on strict mathematical
expectation. Since the basis for making such calculations does not exist.
Regrettably, perhaps due to his work being rather vague and less than
straightforward, Keynes scientific discourse and warnings have not been continued
and evolved by follow-on financial economists. Apart from his less than scientific
discussion about the actual investors expectations and decision-taking being

19
Bodie, Kane and Marcus, 1999, Investments, Chinese edition, China Machine Press. See p. 746. Quotation.
20
Prospect Theory was established by Kahneman and Tversky in 1979 and later became one of the building blocks
of Behaviroal Finance.
39

extensively referred to,
21
his truly valuable perceptions have been basically ignored
and left alone by the latter economists, including his statement regarding the use of
mathematical expectation to represent the investors expectations and
decision-taking.
Connotations of Rational Expectations theory
The concept of Rational Expectations was first introduced in Muth (1961).
According to Muth (1961, p. 315-316), the purpose and basic connotations of putting
forward Rational Expectations are as follows:
In order to explain fairly simply how expectations are formed, we advance the
hypothesis that they are essentially the same as the predictions of the relevant
economic theory. In particular, the hypothesis asserts that the economy generally
does not waste information, and that expectations depend specially on the structure of
the entire systemthat expectations of firms (or, more generally, the subjective
probability distribution of outcomes) tend to be distributed, for the same information
set, about the prediction of the theory (or the objective probability distributions of
outcomes.
In the 1970s, Robert E. Lucas formulated the Rational Expectations Theory on
the basis of Muth (1961). The Theory of Rational Expectations can be defined as
follows: expectations can be based on all the available facts and information to ensure
consistency with the most accurate forecast of the future. In other words, Rational
Expectations equal the optimal forecast using all available information.
22
To demonstrate whether the Theory of Rational Expectations has been able to
scientifically describe how participants in economic life formulate their expectations,
the present author will use the instance of the investors expectations in the stock
market to carry out a comparative analysis on the Theory of Rational Expectations.
Comparative analysis
Studies conducted by the present author on the Theory of Rational Expectations
indicate that, from the surface, the Theory of Rational Expectations seems to be more

21
Such as the beauty contest in the newspaper. Due to the reason that Keynes did not add the investor ideal to his
theory, so his discussion was quoted as the irrationality of the investor in the stock market.
22
Same as 5. See Chapter 27, Pages 655-657. Quotation. A more commonplace definition on the theory of
Rational Expectations is as follows: Rational Expectations are forecasts which, while not necessary correct, are
the best that can be made given the available data. Rational Expectations therefore, cannot err systematically. If
expectations are rational, forecasting errors are pure random numbers. See p. 787. Quotation. Baumol,
William J .and Blinder, Alan S., 1997, Economics: Principles and Policy, 7
th
edition. Harcourt Brance & Company.
40

reasonable than the static expectation or adaptive expectation theory, unfortunately,
due to the following major reasons, the Theory of Rational Expectations cannot help
us to scientifically explain how the investor formulates his expectations of the future
stock price.
First and foremost, the Theory of Rational Expectations wrongly describes the
way that the investor anticipates the future situation.
From the patterns of the investors expectation of the future stock price, the
actual investor relies on three expectation patterns mentioned by the present writer in
anticipating the future stock price. The Theory of Rational Expectations assumes the
investor relies on the basis of mathematical expectation in anticipating the future
conditions.
From the capacity of absorbing information and information processing
capabilitys standpoints, as the human brains have rather limited capacities for
absorbing and processing information at given unit times. In actual fact, the investor
can only process and handle very limited amount of information. In addition, when
forming expectation of the future stock price, the human brain has specific limits on
the quantity and quality of the information received. When forming expectation of
the future stock price, non-stock-price-information simply cannot make its way into
the investors price expectation system. In fact, the overwhelming majority of such
information makes it way into the expectation system that is fully independent of the
investors stock price expectation system. But, the Theory of Rational Expectations
assumes that: the investors are capable of absorbing and processing all available and
relevant information efficiently when they form their expectations of the future status.
Secondly, the theory has also mistakenly described the investor rationality.
The rationality of Rational Expectations refers to that, when investors form their
expectations of the future status, they can make efficient use of all the available and
relevant information. Consequently, when forming expectation of the future status,
they do not make systematic errors of judgment in this regard. For this reason, the
investor will form unbiased expectation of the future status. From this perspective,
the investor expectations are rational.
From the source of the investors rationality, in the actual stock market, the
source of the actual investor rationality lies in that: the investor rationality originates
from the investor aspirations. As the investor aspirations and logic are hidden in the
three expected values on the part of the investor, if we cannot scientifically describe
41

the foregoing three expected values, we will be unable to scientifically describe
investor rationality.
From the standpoint of the creation of the investors rationality, creation of the
investors rationality can be divided into two parts, viz. investors expectations system
and decision-making system.
(i) When anticipating the future stock price, the actual investor has three
expectation patterns, as they are at different levels with different task-sharing
specified, each pattern serves different functions. To scientifically describe the
investors three expectation patterns marks the first step in our understanding of the
investors rationality.
(ii) The investors decision-making system mainly comprises four parts, viz. the
investors expectation values (three), the investors assessments of the
non-stock-price-information, currently earning/loss-making of the investors funds
and the investors requirements imposed on his own behavior. How to make
decisions on the part of the investor is dependent upon the integration outcome of the
four constituent parts of the investors decision-making system. To scientifically
understand the investors decision-making system represents the second step in our
understanding of the birth of the investors rationality.
The actual investors rationality originates from the whole process of connecting
the investors expectation system -- the investors decision-making system viz. the
outcomes of the final decisions.
Lastly, the Theory of Rational Expectations has erroneously captured the
relationship between the investor rationality and investor expectations.
Although the Theory of Rational Expectations advocates may have realized that
the patterns of the actual investor formulating his expectations might be closely bound
up with human rationality. As they do not understand the patterns of anticipating the
future stock price and the structure of the birth of rationality on the part of the investor,
they are simply not in a position to perform any scientific description on the
relationship between investor expectations and rationality.
(i) In the absence of any scientific understanding of the foregoing differing
patterns and levels of the actual investor expectations along with the involved
connecting process, the Theory of Rational Expectations advocates have absurdly
mixed up the differing patterns and levels to become one single pattern and level.
Consequently, the real rationality on the part of the actual investor is subdued during
42

the course of the mixing up.
(ii) According to the Rational Expectations Theory, expectation is rational
because of the following: The investors could make full use of all the available and
relevant information in forming the expectations of the future status. As a result,
whether the investors expectations are rational or not is dependent upon whether he
is able to make effective use of all the relevant information in formulating
expectations of the future conditions.
In Chapter 2, the present paper has already specified that, because of the reason
that the channel capacity of the framework for forming the expectations of the future
stock price on the part of human brains appears to be limited, the external information
being input is rather limited. Moreover, the demand on the quality of the external
information is rather stringent. As a result, when the investors form their
expectations of the future stock price, the majority of the external information just
cannot enter the stock price expectancy system of the investor. In fact, when
forming expectations of the future stock price (such as intuitive expectation), the
human brains only use very limited information. As the investors rationality stems
from the whole process of connecting the investors expectation system the
investors decision-making system viz. the outcomes of the final decisions, the linking of
the investors rationality with the investors expectations alone by the Rational
Expectations theory is highly unscientific.
(iii) Of the three kinds of expectations of the future stock price on the part of the
investor, the intuitive prospect and the momentum prospect are in-born mechanisms
on the pat of the investor, whereas historical experience-based prospect is forged
through training. As the intuitive prospect and the momentum prospect are similar
to human listening and sensing organs of the human body, the use of rationality to
characterize a normal function of the human body is highly unscientific. For
example, rational listening and rational sensing sound rather absurd. Apparently,
it is rather far-fetched for economists to integrate rationality with expectation.
We can clearly see from the above analysis that there is no interrelationship at all
between the Rational Expectations Theorys expectation and rationality versus the
relationship between the investors expectation and rationality under actual
circumstances. Therefore, the rationality of the Rational Expectations Theory is not
the reasonable approximation of the actual investor rationality. Nor is the
expectation of the Rational Expectations Theory the scientific account of the actual
43

investor expectations.
Research conclusions
Based on the above comparative analysis, we can see that the Rational
Expectations Theory is founded upon the basis which is totally inconsistent with the
actual investors expectations and rationality. For this reason, the Rational
Expectations Theory is far from a scientific theory. The reason is partly attributed to
that, irrespective of J ohn F. Muth or Robert E. Lucas, they have not carried out
scientific study on the most fundamental issue associated with how the actual investor
formulates his expectations on the future stock price. Although Muth (1961, p. 315)
recognized the following:
What kind of information is used and how it is put together to frame an estimate
of future conditions is important to understand because the character of dynamic
processes is typically very sensitive to the way expectations are influenced
However, his paper mentioned above does not explicitly discuss how to
formulate expectations of the future status on the part of the investor along with the
involved issues of concern. For example, Lucas (1978, p. 1429) indicated the
following:
As Muth made clear, this hypothesis (like utility maximization) is not
behavioral: it does not describe the way agents think about their environment, how
they learn, process information, and so forth
Due to the unscientific nature of the Theory of Rational Expectations, the theory
simply cannot be used to render any substantive assistance in terms of describing and
explaining the actual investor expectations and stock price behavior. To view it as
reasonably close to the actual investor expectations will result in serious misleading
for people in their understanding of the actual investor expectations and the stock
price behavior.
(i) According to the Theory of Rational Expectations: if a certain variable leading
to the formation of expectations changes its pattern of change, the way of the
formation of the expectations of this variable will also undergo change. In reality, of
the three kinds of expectations associated with the investor anticipating the future
stock price, the intuitive prospect and the momentum prospect are innate for the
44

investor, whatever changes occur for the stock price movement pattern, the investor
will experience no change at all in respect of his way of formation of expectations of
the future stock price. What actually changes is the value of the expectations instead
of the way of formation of expectations of the future stock price.
(ii) According to the Theory of Rational Expectations, it is impossible for us to
observe the forecasting error, viz. the difference between the actual variable and the
expected variable. The reason is that we cannot observe the expected price of the
stock price. Consequently, we cannot observe the forecasting error. As a matter of
fact, it is rather easy for us to observe the forecasting error in the stock market (the
difference between the actual stock price and the expected stock price). In Section 2,
the present paper has already mentioned that it is rather easy for us to observe the
intuitive prospect and the momentum prospect. As a result, it is very easy for us to
observe the forecasting error of the stock market.
For example, the 1987 stock market crash and the 2000 Internet stock price
bubble are clear cases in point. According to the viewpoint of the Theory of
Rational Expectations, irrespective of the US stock market crash in 1987 or the US
Internet stock price bubble, they are simply unforeseeable. Conclusion contrary to
the Theory of Rational Expectations, irrespective of the 1987 stock market crash or
the 2000 internet stock price bubble in the United States, these events could have been
foreseen. In actual fact, we can use a group of mathematical models to make
scientific forecasts about these stock price crashes and bubbles in advance.
(iii) Although theorists of Rational Expectations have observed the following
phenomenon: It seems that the outcomes of economic life (such as stock price
behavior) match peoples expectations, it is rather difficult for people to try to explain
these phenomenon. The Theory of Rational Expectations assumes the following:
Economic agents form their expectations as if they know the process which will
ultimately generate the actual outcomes in question-i.e., peoples subjective
probability distributions describing future conditions are identical to the
corresponding objective probability distributions conditional on the true model of
the economy.
23
Although the explanation deduced from the above assumption may
sound plausible, it is totally inconsistent with the actual fact. It is known to all that
peoples expectations (irrespective of the intuitive prospect, the momentum prospect

23
See Friedman, Benjamin M., (1979), Page 23. Quotation.
45

or the historical experience expectation) are highly unreliable. Advocates of the
Theory of Rational Expectations attribute the above phenomenon to the reason that
people have Rational Expectations, and they have undoubtedly found the wrong
source.
24
6.2 Rational Investor
According to Barberis and Thaler (2003, p. 2), rationality is defined in the
following terms:
Rationality means two things. First, when they receive new information, agents
update their beliefs correctly, in the manner described by Bayes law. Seond, given
their beliefs, agents make choices that are normatively acceptable, in the sense that
they are consistent with Savages notion of Subjective Expected Utility (SEU).
As the concept of rationality is of crucial importance to verifying whether the
investor and stock price behaviors are rational, to reach a correct judgment on whether
the concept of the rational investor has scientific connotations, the present author has
performed comparative analysis between the EMT-specified rational investor
behavior and actual investor behavior.
In terms of human nature, rational investor is a self-seeking, egocentric and
cool-headed calculator. In actual life, the investor is both self-seeking and altruistic
at the same time. What is of crucial importance is that the real investor is aspiring
whereas the rational investor is just soulless.
In terms of ways of thinking about the stock price behavior. The rational
investor thinks about the stock price behavior in terms of probability distribution.
The real-life investor thinks about the stock price behavior by relying on his intuitive
method of cognition and empirical statistics. It is only a very limited number of
specially trained personnel (such as mathematicians) who can attempt to think about
the stock price movement in terms of probability distribution on the basis of reliance
on their intuitive method of cognition.
In terms of capability to process information. At the time of the expectation
formation, the rational investor would use all the available information at his disposal
and process the information at hand in an efficient way. The real-life investor, on the

24
Outcome of economic life (such as stock price behavior) matching peoples expectation for the following real
reason: peoples aspirations. Due to limitations of subject matter and space, the present author is not prepared to
go any further on this particular issue.
46

other hand, would have limited information processing capability and, in the face of
several or numerous sources of information, would find it hard, if not impossible, to
intelligently process the information at hand to reach the best possible forecasting
conclusion.
In terms of methods of expectations of the future stock price. The rational
investor relies on mathematical expectation to form expectations of the future stock
price. The real-life investor, on the other hand, would never rely on mathematical
expectation methods to form expectation of the future stock price, and would, more
often than not, rely on the three methods mentioned in Section 2 of the present report,
in forming expectations of the future stock price.
In terms of methods of updating belief. Rational investor would update their
beliefs according to the Bayes rules and make decisions according to the Expected
Utility theory. Real-life investors would formulate their investment decisions on the
basis of the methodology outlined in section 2 of the present report, and update their
beliefs on the basis of the differential between the realized outcome and the expected
outcome. The amount of investment involved on the part of the actual investor is
predicated on the investor aspirations and confidence.
From the above discussion regarding the rational investor, we can deduce that, it
is impossible for the rational investor to possess the real human nature and
rationality of a true human being. And the rational investor would behave in a way
that is inconsistent with the real-life investor in all critical aspects involved. At the
end of the day, the stock price behavior boils down to the result of the investor
behavior, the stock price behavior deduced from the EMT is poles apart from the
stock price behavior deduced from the real-life investor behavior.
According to the EMT logical deductions, in a perfect competitive market,
25
the
self-seeking and profit-pursuing nature on the part of the perfectly rational investor
makes the stock price changes randomly and completely unpredictable. With the
increase of the market efficiency, the stock price becomes ever more unfathomable.
In a perfect efficient market, the price changes would be totally random and are
completely unpredictable. To the mind of the EMT theorist, an ideal stock market is
a perfect efficient market. That is to say, an investors ideal market is a market

25
The research results by the present author demonstrate that, as the scholars have not reached a complete
understanding of the stock market, the terminology of perfect competition has its own special economics
connotations, and is therefore not fit for use in describing the nature of the stock market. Due to lack of space
and subject matter, the present author is not prepared to discuss this issue in detail.

47

where the price changes are completely unpredictable. Is a market where the stock
price movement is totally unpredictable really a market where the investors harbor
their aspirations? The answer is an outright no. By taking a look at the comparison
between my statements on the investor ideal stock market in Section 2 and the above
deductions, we will be able to easily arrive at the foregoing conclusions.
Please pay attention to the statement of the above sub-section:in a perfect
competitive market, the self-seeking and profit-pursuing nature on the part of the
perfectly rational investor makes the stock market price changes randomly and
completely unpredictable. Based on the discussions in Section 2 earlier, it is only
in the ideal stock market that the investor becomes perfectly rational. In a real-life
idealized stock market the perfectly rational investor could never be self-seeking. In
reality, due to the contradictory nature of the perfectly rational and self-seeking
conditions of the investor, they cannot co-exist at the same time. However, when
describing the stock price behavior, EMT theorists invariably intermingle the two
mutually contradictory and co-existence-proof conditions of the investor. To the
mind of the EMT theorists, perfect rationality and selfishness of the investor are
nothing more than mere convenient hypotheses. As for whether they really exist or
not, or whether they are mutually contradictory to each other, EMT theorists simply
do not care at all. The issue is: if we do not examine the investor behavior with a
scientific attitude, how can we scientifically describe the stock price behavior? And
how can be scientifically clarify the interrelationship between the investor behavior
and stock price behavior?
It should be noted that, as the research work performed by psychologists
Kahneman and Tversky
26
(1974), (1979), (1981) and (1986) along with the economist
Herbert A.Simon
27
and Vernon smith,
28
the hypothesis of rational investor has been
subjected to increasing challenge by financial and psychological scholars.

26
Kahneman and Tversky showed that: under the uncertainty, the behavior of the investor decision-making will not
be the same as predicted by the modern decision-making theories. They established the Prospect Theory to try to
explain the actual behavior of the investor decision-making. For the latest research conclusion, please see
Kahneman (2005).
27
The Nobel laureate Simon believes that the investor is only rational to a limited extent, and is very different from
the rational investor assumed by the mainstream micro-economics. Faced with the future uncertainties, people
only rely on satisfaction instead of profit maximization to take decisions. For instance, Simon (1955), (1982).
Unfortunately, his research results have exerted very little impact on the financial economists.
28
Vernon Smith research results demonstrate that the investor is not as selfish as a rational economic agent is. On
the contrary, they would display mutually beneficial behavior. See Smith (2001).
48

6.3 Arbitrage
29
The concept of arbitrage lies at the heart of the capital market theories.
According to Sharpe and Alexander (1990), arbitrage is defined as:The simultaneous
purchase and sale of the same, or essentially similar, security in two different markets
for advantageously different prices.
First and foremost, arbitrage requires the simultaneous purchase and sale of equal
amounts of securities such that profit may be sought from the differential between the
prices. Consequently, irrespective of the traditional arbitrage model or the
professional arbitrage model described in Shleifer and Vishny (1997),
30
the working
of arbitrage inevitably involves the calculation of the expected return of the involved
securities. As a matter of fact, whether the investor can correctly calculate the
expected return of the involved securities constitutes the key to the profit-earning for
the arbitrage strategies adopted by the investor. Unfortunately, as the standard
financial theories give the wrong calculation formula associated with the expected
return, the working of the traditional arbitrage model or the professional arbitrage
model is actually founded upon the wrong calculation methodology applicable to the
expected return of the involved securities.
As the standard financial theory provides the wrong methodology associated
with the calculation of the securities expected rate of return, if the investor adopts
the above arbitrage strategy, it becomes impossible for the investor to obtain any
return in a reliable fashion. On the contrary, significant investment risks would
arise. If arbitrage cannot bring about any reliable return for the investor and could
create enormous risks for the investor, the investor would clearly prefer not to use
arbitrage as their main investment strategy.
Secondly, the present writers research over the investment strategies on the part
of the investor demonstrates that, in real-life stock market, 80% investors adopt the
momentum strategies and contrary strategies. Investors seldom adopt the rational
arbitrage strategies as claimed by efficient market theorists. The reason is as
followss Rhe investor aspirations, investor approach of anticipating the future and

29
In this context, we limit our discussion to risky arbitrage instead of pure arbitrage.
30
According to Shleife and Vishny (1997), the traditional risky arbitrage refers to the following: in traditional
models, arbitrage in a given security is performed by a large number of diversified investors taking small positions
against its mispricing. Professional arbitrage refers to that arbitrage is conducted by a relatively few professional,
highly specialized investors who combine their knowledge with resources of outside investors to take large
positions.

49

investor interpretation of the stock price sequences determine that the overwhelming
majority of investors can only adopt the momentum strategies and contrary strategies
to press ahead with their investment. Irrespective of the investors of the 1920s or
the investor of today (with the possible exception of economists and statisticians) do
not resort to arbitrage to form the main investment strategy associated with the stock
market.
31

The present writers study of the daily statistics of DJ IA over 102 years has
shown that, amongst approximately 28000 figures, almost 13000 figures fall under the
category of standard stock price patterns. Approximately 8000 figures fall under the
category of being interrupted by external factors. Around 2000 figures fall under the
category of independent movement patterns. Only around 4000 figures do not fall
under any particular category, and they represent roughly 14% of the total. The
trends contained in the DJ IA data clearly indicate that: if the US Stock markets are
efficient markets as proclaimed by EMT theorists, it is impossible 13000 figures out
of 28000 to fall under the category of standard price movement patterns. What is of
crucial importance is that the patterns of movement of the stock price contained in the
DJ IA data are essentially consistent with the investors modes of expectations of the
future stock price and investors way of interpreting the stock price sequences.
32

This proves from that angle that the research conclusions drawn by the present writer
regarding the momentum strategy and the contrary strategy being adopted by the
majority of investors are correct.
At the same time, the apparent trend contained in the data indicates that the claim
by the EMT theorists that the working of arbitrage could bring stock price close to the
fundamental value (so the market efficiency could be maintained) is totally void of
solid scientific foundations.
Lastly, in the real-life stock markets, the investment strategy to be adopted by the
investor is predicated on the following: the actual stock price behavior and the actual
investor behavior and the general outcome of the foregoing two elements ---investor
rationality, investor attitude towards risk and the stock price formation mechanism.
Research performed by the present writer has demonstrated that, due to lack of
scientific understanding of the actual investor behavior and stock price behavior, it is

31
Shleifer and Vishny (1997, p. 16) has also observed the same point: In contrast, there is much less evidence of
such activity in the stock market, either in the United States or abroad.
32
Research work performed by the present author has indicated that there is a clear cause-effect relationship
between the investors modes of anticipating the future and deciphering the stock price sequences and the stock
price movement patterns.
50

impossible for people to systematically understand and take advantage of the arbitrage
opportunities in the stock market. Even though a minority of the investors can
understand and make use of the arbitrage opportunities in the stock market, their
behavior could not exert any substantive impact on the price behavior of the stock
market (we will touch on this aspect in detail in the latter part of this sub-section).
By integrating the conclusions drawn at the end of Section 2 with the above three
points, we would be in a position to make the following judgment: as the investor
behavior and stock price behavior portrayed by the standard financial theories are
completely inconsistent with the actual investor behavior and stock price behavior,
the arbitrage strategy has been blown out of proportions in the stock market. As
one of the bases of EMT is established upon the existence of perfect arbitrage in the
stock market, the theoretical foundation of EMT becomes untenable.
33

Research work conducted by the present writer has also verified Shleifer
(2000)s judgment on arbitrage: Even under conditions close to textbook descriptions,
the effect of arbitrage is very limited. Under even more complicated conditions, its
effect would be even smaller. Once careful consideration is given to the models of
arbitrage in real life, EMT assumptions concerning arbitrage effectively become
meaningless.
6.4 Equilibrium
Based on the definition, equilibrium of the stock market refers to the stock
demand quantity equalizes with the stock supply amount at a given price level. At
the equilibrium price point, the investors supply and demand matches each other and
there is no desire to see any further change in the stock price. Financial theorists
proclaim that, in actual stock market, competition among rational investors would
enable the stock market to achieve equilibrium, and arbitrage is viewed as the critical
factor to maintain the equilibrium of the stock market.
The concept of equilibrium is one of the most important and difficult concepts of
economics. Regrettably, regardless of the economists or the financial scholars, they
invariably view the stock price equilibrium as given, with few of them paying any

33
According to Shleifer and Vishny (1997, p. 19): Theoretically, the efficient markets approach is based on the
assumption that most investors, like economists, see the available arbitrage opportunities and take them. Excess
returns are eliminated by the action of a large number of such investors, each with only a limited extra exposure to
any one set of securities.

51

attention to and performing research over the stock market trend of moving towards
equilibrium. Consequently, the present author vehemently hopes that the analysis
that follows will be conducive to assisting economists to form scientific judgment on
whether equilibrium is fit for describing the actual status of the stock market.
The present authors research over whether the real-life stock market can reach
equilibrium or not demonstrates that: because the actual stock price behavior is
mainly predicated on the three critical factors: the modes of expectations of the future
stock price and the mode of decision taking on the part of the investor, and investor
aspirations, hence no need or incentive to enable the stock market to reach the state of
equilibrium.
First and foremost, it is known to all that what the real-life investor is concerned
about is the transaction price rather than the transaction quantity of the stock. Due to
the breakthroughs achieved on the patterns of anticipating the future stock price,
through a group of mathematical formulas, we are in a position to calculate and
actually observe the investors expected prices. The investors expected price can be
further subdivided into the price at which the investor is ready to buy in and the price
at which the investor is ready to sell out.
34
On the basis of the foregoing, we refer to
the buying price on the part of the investor as the market demand price, and regard the
price level at which the investor is willing to sell as the market supply price.
According to the market price data day in and day out, we can easily calculate the
market demand and supply price for tomorrow. On this basis, we can easily
calculate the price equalizing with the market demand price and market supply price.
Due to the fact that this price is different from the equilibrium price of the standard
financial theories, the price is only an equilibrium price defined on the present
authors terms. If we assume that, at the price point where the market demand price
equals the market supply price, the quantity of the stocks that the investor is ready to
supply equals to the quantity of the demand of the investor, we can then draw the
conclusion that this price is the actual equilibrium price of the stock market.
In the actual stock market, what the investor is concerned about is the stock price
behavior, and the investor is basically not concerned about the quantities of shares
being traded at all. Supposing that the investor is concerned about the quantities of

34
As the investor has three expected values at the time of forecasting, at any given point, the investor has the
intention to either buy in or sell out, although there is a clear difference between the weightings of buying in and
selling out. As the standard financial theory assumes that the investor forecasts the future in a mathematical
manner and that the investor is a rational economic agent, it is impossible for us to actually observe the expected
price on the basis of the standard financial theory. Nor is it possible for us to observe the price at which the
investor is willing to buy in or sell out.
52

shares being traded, such quantities are merely regarded as a reference parameter for
analyzing the stock price behavior. That is to say, although any one stock price
sequence contains the aspirations, expectations and logic on the part of the investor,
any one stock trading quantities sequence does not contain the aspirations,
expectations and logic on the part of the investor. Consequently, even though we
have adequately long historical sequences of the quantities of the stocks traded, the
investor is unable to forecast the quantities of the involved future stock on the basis of
the patterns of expectations. That is to say, we will be unable to calculate the market
demand and market supply quantities through mathematical formulas. Consequently,
we will be totally unable to calculate and observe the stock quantity when the market
is at equilibrium where the investors demand quantity equals the investors supply
quantity.
35
Secondly, even though we can calculate and observe the investor-expected price,
it is, after all, only one of the three expected prices of the investor. As the real-life
investor has three different prospect values at the same time in formulating future
stock price forecasts, viz. there are three groups of different market demand price and
market supply price at the same location/time for any stock market. If the
equilibrium theory is complied with, viz. the investors demand/supply forces reach
equilibrium, the price has no intention of changing. Under such circumstances, the
first prerequisite for the actual stock market to reach equilibrium is that the three pairs
of market demand price and market supply price must be equal. Otherwise, even
though the first pair of the market demand price and supply price are equal, and the
second and third pairs are not equal, the stock market price is then still motivated to
change.
Regrettably, my studies of the daily data sequences of DJ IA over 30000 days
within the past 110 years indicate that the investors three pairs of different market
demand price and market supply price have never equalized. That is to say, over the
past 110 years, the largest stock market in the world has never reached equilibrium.
As the investor ideal mainly stems from the historical tempering of the stock price
behavior, if, over the past 110 years, the stock market has never been able to reach
equilibrium, how is it possible for the contemporary investor to fiercely compete to

35
Based on the definitions concerning the quantities of supply and demand associated with economic theories and
standard financial theories when market reaches equilibrium, it is impossible for us to observe the actual quantities
of supply and demand. Consequently, it is just impossible for us to observe the equilibrium of the market. That
is to say, it is impossible for us to observe the equilibrium price of the stock market.

53

make the stock markets of today and tomorrow to move towards equilibrium?
Lastly, the following two key aspects do not support the trend of the stock
market moving towards equilibrium.
(i) Investor aspirations constitute the bedrock of the stock price movement.
Regardless of a single investor or the investing community, investor aspirations are
always contrary to static equilibrium of the stock market. Therefore, the actual
investor is never motivated to enable the stock market to reach equilibrium.
(ii) As the stock market investment demand is dependent upon the investor
confidence, and the investor confidence, in turn, hinges on the success rate of the
investor decision-making, and investor decision-making is mainly predicated on the
investors three expected values. If the investors three expected values have never
equalized, the investor will not have any confidence in the stock market reaching
equilibrium. If the investor lacks confidence, he would have no motivation to
continue to invest with the result that the market simply lacks the needed driving force
to enable it to reach equilibrium.
Hayek (1945, p. 530) points out the following in a scientific manner:-
I am far from denying that in our system equilibrium analysis has a useful
function to perform. But when it comes to the point where it misleads some of our
leading thinkers into believe that the situation which it describes has direct relevance
to the solution of practical problems, it is time that we remember that it does not deal
with the social process at all.
Based on the above conclusions, the present author can deduce and state that the
concept of equilibrium may not be fit for use in describing the state of the actual stock
market. The so-called equilibrium price and the equilibrium rate of return of the
stock market are of no practical value.
6.5 Is EMT the reasonable approximation of the reality?
When the economists bring together the above basic elements, the randomly
changing stock price behavior and a series of attendant assumptions, economists can
deduce the EMT. The question is: as all the raw materials making up EMT do not
have any scientific connotations, is it possible for their combinations to contain
54

scientific contents? In other words, is the EMT founded on the wrong stock price
behavior and unscientific investor behavior a rational approximation of the stock
market realities? The answer, unfortunately, is negative.
Stock market status portrayed by EMT
When economists bring together the critical elements along with the attendant
assumptions including the random changes of the stock price behavior, the Rational
Expectations Theory, the concept of equilibrium, the rational investor and arbitrage, it
is rather easy for economists to deduce the status of the efficient market.
According to Frederic S. Mishkin: When the monetary economists set up the
Rational Expectations Theory, financial economists have set up a Rational
Expectations Theory in the financial market. Such theory results in the same
conclusions as Rational Expectations Theory: the expectations in the financial market
represents the best possible forecast with all the available information in the financial
market taken into full consideration. Although financial economists have assigned
different names to their respective theories, referring to it as efficient capital market
theory or efficient market theory. In actual fact, it is only an application of the
Rational Expectations Theory in securities pricing.
36

EMT regards expectations of the financial market as the best forecast on the
basis of having taken into account all the available information. In other words, the
market expectations are rational. Consequently, the following formula applies:
of
t
e
t
P P
1 1 + +
= (4)
Conversely, it means the expected return of the involved security will be equal to
the best forecast made of its return:
of e
RET RET = (5)
According to the principle of supply and demand, the expected rate of return of
a certain kind of stock tends to move towards equilibrium until such time when the

36
Id to 5, See Chapter 27, p. 655-658. Quotation.

55

supply and demand equalize with each other. At the time of equilibrium, the
expected rate of return of one stock is equal to the average rate of return for the
involved stock:

= RET RET
of
(6)
Through replacement, we can obtain the following pricing formula in the
efficient market:

= RET RET
of
(7)
Such equation effectively tells us that, current prices in a financial market will be set
so that the optimal forecast of a securitys return using all available information
equals the securitys equilibrium price.
In the above formulao represents the expected price. stands for the
optimal expected price with all the market information taken into full account.
e
t
P
1 +
of
t
P
1 +
e
RET
is the expected rate of return.
of
RET is the best possible rate of return with all the
available market information taken into full account.

RET stands for the average

rate of return.
Based on the above formula, economists can deduce the core connotation of
EMT-- there is no untapped earning opportunity in the stock market.
37

The above core concept does not appear to be easily understandable to the
general public. In Malkiel (2003, p. 5), Malkiel uses the old story to describe the
connotations of the efficient market status with brevity:

37
Id to 5, See Chapter 27, p. 658--660. Quotation. With the emergence of the Rational Expectations and Fama
(1976), theorists were able to integrate EMT with Rational Expectations and CAPM resulting in the further
reinforcement of the core connotation of EMT. That is to say, the stock price in the capital markets not only fully
reflects all the available information, but also correctly reflects all the available information. That means, in an
efficient market, the stock price is equal to its basic value or intrinsic value. With the emergence of Grossman
and Stiglitz (1980) and a large number of other research work identifying inconsistencies with EMT, theorists have
managed to carry out further revisions on the connotations of EMT. The core connotation of EMT has been
revised to be: The stock market contains no excess risk- and transaction-cost adjusted profit opportunities that are
yet to be exploited.

56

A well-known story tells of a finance professor and a student who come across a
$100 bill lying on the ground. As the student stops to pick it up, the professor says,
Dont bother---if it were really a $100 bill, it wouldnt be there. The story well
illustrates what financial economists usually mean when they say markets are
efficientIn short, we believe that $100 bills are not lying around for the taking,
either by professional or the amateur investor.
On the surface, the stock market status represented by EMT appears to be a
replica of the actual stock market. Unfortunately, what resembles truth does not
necessarily mean that it is truth. Although EMT stories are very convincing, it is not
fit for use in capturing the actual status of the stock market.
Actual status of the stock market
However, when we integrates the changing-by-rules stock price behavior, three
forms of actual investor expectations, investor ideal, limited information processing
and forecasting capabilities on the part of the actual investor along with a
combination with the stock pricing formula drawn up by the present author, we can
easily deduce that: in the stock market, there exists profit opportunities that have not
yet been tapped, just like the society in which we are living now with profit
opportunities that have not been taken advantage of.
When we integrates the three forms of actual investor expectations, investor ideal,
limited information processing and forecasting capabilities on the part of the actual
investor along with a combination with the stock pricing formula drawn up by the
present author (the basic formula of the stock pricing is as follows:
38
g 8 ) , , , ( M T V P f P
h
=
P in the above formula refers to the future stock price, refers to historical
sequence of the stock price, v refers to the basic background, t stands for time frame
consistent with human psychology, behaviour and market habitudes, and m stands for
investor),
h
P
We are in a position to reach the following conclusion: except all the investors share

38
For details, please refer to the present writers research paper entitled Pattern and Forecast of Movement in
Stock Price.
57

the same views on the interrelationship among the four elements in the above formula,
it is impossible for All the investors three expected values to be the same and
identical. If the investors three expected values are different, it follows naturally
that the investors investment decisions are certainly different. As a result, the
realized stock price is sure to be different from that anticipated by the investors.
Consequently, the stock price inevitably fluctuates upwards or downwards.
When we integrate the stock price behavior following fixed rules with the above
conclusions, we can reach the following core conclusion: the downward and upward
movement of the stock price following fixed rules means that the stock market
contains untapped profit opportunities.
39
From the history of the stock markets in
the world, we can see that, irrespective of the US stock market 100 years ago, or the
current US stock market, the stock price invariably stays in a state of flux and
fluctuation. And, once in a while, the magnitude of such fluctuation could be rather
high. That is to say, from the past to the present time, the stock market always
contains profit opportunities that have not yet been fully tapped.
The comparative analysis of these two stock market status
These untapped earning opportunities in the stock market are quintessentially
different from the presence of a $100 bill in the Wall Street.
From a time standpoint, the $ 100 bill in the Wall Street is fixed in terms of value
and price, and will not change with time. However, the untapped earning
opportunities do not exist for a protracted period of time, and are prone to change with
the passage of time.
From the point of view of the source of the creation/disappearance of these
untapped earning opportunities, as the investors three expected values of the future
stock price are different, the involved stock price will inevitably fluctuate giving rise
to the untapped earning opportunities in the stock market. As the stock price is the
most important criterion determining the predilection of the investor and changes of
the stock price will in turn lead to new change in the investors three expected values.
Investors three expected values are different from each other stock price
experiencing change (birth of the untapped earning opportunities) the investors

39
This paper is the third one in the present authors series of research papers. Due to limitations of subject matter
and space, the above discussion has been rather simple. The present author will dwell on this particular topic in
another research paper later on.

58

three expected values experiencing new change (new differences). And these
untapped earning opportunities also experience an occurrence--disappearance--
reemergence cycle.
As the stock price always remains in a state of change, these untapped earning
opportunities change in tandem with the change in the stock price keeping in a state of
occurrence--disappearance--rebirth cycle.
From the point of view of identification, everyone can envision a $100 bill lying
in the Wall Street, and pick it up for good use. In the same vein, can the investor
identify the untapped earning opportunities in the stock market? Unfortunately, the
answer is both affirmative and negative at the same time.
It is affirmative because, theoretically speaking, the untapped earning
opportunities are the outcome of the behavior on the part of the investors. With our
scientific understanding of the investor behavior, we are in a position to identify such
untapped earning opportunities in the stock market. The answer is negative because,
in reality, the present writer has been unable to find any systematic proof linked with
the scientific understanding of the three expected values on the part of the investor.
40

That means that very few investors can systematically identify the untapped earning
opportunities in the market. Without a scientific understanding of the three expected
values on the part of the investor, we are sure to be unable to fully discern the
foregoing untapped earning opportunities in the stock market.
Although we have been able to find some practical evidence showing the
successful investors beating the market, up to date, on the crucial question of how to
pass judgment on the performance of these successful investors, controversies remain.
For instance, should their success be attributed to luck, or to their knowledge and
techniques associated with the identification of the untapped earning opportunities in
the market and so on and so forth. All in all, economists have been unable to make
any scientific judgment to date (the present writer will deal with this matter in the
sections that follow).
Can the actions on the part of these successful investors root out the presence of
such untapped earning opportunities in the market?
If a minority of successful investors can systematically identify and make use of
such untapped opportunities in the market, Can the actions on the part of these

40
Up to now, although behavioral finance scholars have discovered a large number of evidence pointing to the
inconsistencies with EMT, such research findings cannot be regarded as systematic evidence associated with the
understanding of three expected values in any scientific manner.
59

successful investors root out the presence of such untapped earning opportunities in
the market? The answer is negative for the following reasons:
Within the context that no shrewd investors have made use of the above earning
opportunities, these unused earning opportunities just keep on repeating themselves in
a cycle of birth disappearance rebirth.
If we make a comparison between the actions on the part of several shrewd
investors in taking advantage of these unused earning opportunities and the behavior
of self-disappearance on the part of the foregoing unused earning opportunities, we
can find that, as the impact exerted by the investors action on the stock market is not
only short-lived, but also of a limited magnitude. Indeed, impact exerted by the
investors action on the entire market is really insignificant. As a result, actions on
the part of these successful investors cannot root out the presence of such untapped
earning opportunities in the stock market. If we make a comparison between the
impact exerted by the investors action on the stock market and the impact exerted by
the behavior of self-disappearance on the part of the foregoing unused earning
opportunities, we can also find that, the impact of the investors actions on the entire
market, compared with the impact of the behavior of the self-disappearance of the
untapped earning opportunities on the stock market, is basically identical.
The root cause and process of these unused earning opportunities have
determined that they will exist on a long-term basis in the stock market. Even
though the action of making use of these unused earning opportunities on the part of
the investor has exerted substantive impact on the entire stock market, certain stock
price patterns (viz. the way of self-display by these unused earning opportunities)
could stay away from the stock market for a long time. This, however, does not
mean that the possibility for the incidence of such unused earning opportunities has
been eliminated from the stock market. The reason is that these untapped earning
opportunities is merely another form of stock price pattern making its appearance in
the stock market.
Even though the successful investor can systematically identify such untapped
earning opportunities in the market, it is no easy thing for the investor to make use of
these untapped earning opportunities to earn profits in a reliable manner. The reason
is that the investor will be facing three insurmountable barriers:
(i) Mutually interrelated four elements in the above equation prescribes an
unbridgeable extreme for any one single investor in terms of making use of the
60

untapped earning opportunities in the stock market. Such extreme is that the
investor will be facing uncertainties. That is to say, the investor will be unable to
define whether he/she will be able to take advantage of the untapped earning
opportunities in the stock market. The investor can only rely on his/her past success
rate and confidence to determine future investment. Even in the case of a successful
investor, in the face of the untapped earning opportunities, compared with other
investors, he will only have the edge of greater possibilities.
It deserves special mention that, different from the uncertainties of the time
sequences of throwing dice and random dealing of the cards, the uncertainties of the
stock market is created by the investors themselves. Such uncertainty changes in
tandem with the changes in the three expected values on the part of the investor in the
stock market.
(ii) As each and every investor is jointly constrained by the four critical factors:
limited capability to process information, limited capability to forecast the future,
unique modes of anticipation of the future and unique way of deciphering the stock
price sequences, any one single investor can only make use of these untapped earning
opportunities in a limited manner. For instance, due to the unique characteristics and
functions of the human brains, biological limitations of human aspects such as
cognition, attention and memory etc., not all changes or movement in time gaps in the
stock market arouse the attention of the majority of investors. In fact, only changes
in time gaps that are related to the psyche, investment habits and biological
characteristics constitute areas of attention and memory for the majority of investors.
As a result, the investor can only make use of those earning opportunities at specific
time intervals.
(iii) As a result of mutual interactions between the investor and stock market in
terms of the part versus the whole as well as the mutual interactions between the
investor and the stock market, there is bound to be a limit on making use of such
untapped earning opportunities in the stock market on the part of the investor in terms
of calculation. The limitation is: within given unit time, there is a calculable extreme
to the fluidity available in the stock market. If the investor fails to take into
consideration such extreme, the investor will not only be unable to take advantage of
these untapped earning opportunities in the stock market, but actually turn his action
into a source of such untapped earning opportunity in the stock market.
Consequently, the net outcome could be totally contrary to the objective set by the
61

investor to make full use of the untapped earning opportunities in the stock market.
Precisely because of these unbridgeable limitations, any one successful investor
can put into place scientific rules governing their own behavior. These scientific
rules, devised to govern the behavior on the part of the investors themselves become
an extremely important part of the knowledge required to make use of such untapped
earning opportunities on the successful investors.
Final reflections
A financial economist has written on the first draft of the present paper in the
following manner:
The EMH does not require the price sequence to be a martingale, it does not
require normality, or any particular price process. Returns can be non-normal and/or
predictableThe EMH does not require perfectly rational agents. It simply requires
that agents can observe systematic cost- and risk-adjusted excess returns and will
arbitrage those away. In other words, it implies that people dont leave money on the
table.
I definitely do not think it should be junked. It is a reasonable description of
reality on which to start. We can and should study how it can be improved.
The present writer believes that many financial economists will share similar
viewpoints. The reason is that, based on the EMT logic, there are thousands upon
thousands of rational investors in the stock market. They are able to identify and
fully utilize these untapped earning opportunities in the stock market. Their working
of arbitrage of seeking profits will ultimately create the situation where there will be
no profit-earning opportunities in the stock market. That is to say, based on the EMT,
the investor is able to systematically identify these untapped opportunities and make
full use of them through arbitrage strategies, and finally eliminate these untapped
opportunities in the stock market.
Regrettably, as mentioned by the present writer earlier, from the past up to the
present time, there have always been profit-earning opportunities in the stock markets
that have not yet been tapped. In the actual stock market, very few investors can
systematically identify such profit-earning opportunities, and eliminate them through
arbitrage strategies. Even though there is a minority of successful investors can
systematically identify such opportunities in the stock market, actions on the part of
such successful investors cannot root out such profit-earning opportunities in the
stock market. After all, even these successful investors cannot make sure that they
62

can make full use of these profit-earning opportunities to derive a reliable source of
return.
As EMT theorists have not yet obtained any scientific understanding of the
actual investor behavior and stock price behavior, the basic elements associated with
the analysis framework used in building up the EMT do not possess any scientific
connotations. These two reasons caused EMT theoretical models to inevitably
confront the problem of model specification errors. In specific terms, EMT
theoretical models have omitted several relevant variables. To provide scientific
descriptions and explanations on the stock price behavior, the most fundamental
condition is that we must be in a position to build up the scientific stock price model.
And, in this respect, the most fundamental condition is that we must be able to contain
all the relevant variants within the model. Regrettably, EMT cannot meet this very
basic condition. As a result, EMT simply cannot be viewed as the starting point of
our study and comprehension of the stock price behavior.
Over the past 3-odd decades, although theorists have carried out further revisions
to the core connotations of EMT, this has been change in form rather than in
substance making it impossible for EMT to become a theory rich in scientific contents
from a theory that has no scientific content whatsoever. The reason is that, the basic
components making up EMT have remained unchanged, and there has been no
change in the logical foundations of EMT as well. As for whether economists
should spend further decades of hard work to refine it, it is a matter of controversy.
As far as the present author is concerned, the road to future development of financial
theory unquestionably lies elsewhere.
Conclusions
A comparison between the stock market status portrayed by the above EMT and
the analysis conclusions drawn by the present author, we can clearly see that EMT is
far from a close approximation to the stock market realities. It is not fit for use as a
scientific starting point in enabling us to understand the stock market behavior.
Although certain realities of the stock market are indeed consistent with the forecasts
of EMT, as, for instance, the investment fund manager does not always beat the
market, but, the crux of the matter lies in that, while it is certainly important to ensure
consistency between a theoretical conclusion or forecast and the actual reality, it is
even more important to ensure that the basis and deduction process of the theory can
63

stand scientific tests. The reason is pure and simple: really scientific theories can
never stand on mistaken foundations.
It should be noted that, in this section, the present author needs to clarify that, in
this sub-section, the present author has no intention of challenging the authority of the
basic principles of economics and finance by analyzing the Rational Expectations
Theory, rational investor, arbitrage and equilibrium. The present author has chosen
to do this due to his hope that the economists can attach importance to the following
reality: the stock market is very different from a production or consuming market.
Consequently, when we apply certain principles and concepts of economics to
describe the stock market behavior, is it possible for us to carry out some appropriate
and reasonable revisions? J ust as LeRoy (1989, p. 1615-1616) comments:
Market efficiency is a complex joint hypothesis. Some elements of this joint
hypothesis are central to economists way of thinking. Like rationality and Rational
Expectations, while others are no more than convenient auxiliary assumptions, like
the Martingale model. Rejection of market efficiency requires that one or more of
these elements of the joint hypothesis be replacedregrettably, it appears as if it is
the assumptions of rationality and Rational Expectations that require reformation
Economists are required to form their theories a clear statement of what observed
phenomena would be inconsistent with these theories.

7 Commentaries on EMT Theorists Viewpoints
From the analyses in the previous few sections, we are in a position to judge that,
Efficient Market Theory is not a reasonable approximation of the stock market reality.
To enable the readership to have a fuller and deeper understanding of the errors and
mistakes with EMT, the present writer will briefly analyze EMTs capability of
interpreting the stock market realities. In specific terms, the present writer will,
selectively, provide a brief analysis and commentary on the viewpoints and research
conclusions advanced by several EMT representative figures in their respective
research reports. The conclusions of the analysis eventually demonstrate the
following: EMT is simply not in a position to provide any scientific explanations on
64

the actual stock price behavior. All the explanations made by EMT theorists are just
paradoxical.
In this sub-section, the present writer will, first of all, dwell on the main
viewpoints of Samuelson (1989), and, second of all, perform a brief analysis on the
conclusions drawn in Fama (1998) and Malkiel (2003) and (2005). Lastly, the
present writer will comment on the viewpoints advanced by Malkiel (2003) in another
paper written by him.
41

7.1 Viewpoints advanced in Samuelson (1989) paper
Samuelson (1989, p. 4-7) states the followings
Those lucky money managers who happen in any period to beat the
comprehensive averages in total return seem primarily to have been merely
luckyThe art of the proficient trader is indeed an art and not a reproducible
scientific method.
Performance on the part of the successful investor is attributed to their
knowledge and investment techniques.
First of all, the present writers research has proven that economists have not
obtained systematic and scientific understanding on the actual investor behavior and
stock price behavior along with their mutual interrelationship. At the same time, the
economists entire framework applied to the analysis of the investor behavior and
stock price behavior is not scientific in nature. Moreover, investors who have
achieved extraordinary returns on their investment are simply not ready to share their
investment analysis and decision-taking process. The above three crucial factors
have created the situation where economists are essentially unable to perform
scientific analysis and judgment on those extraordinary investors who have achieved
abnormal returns on their investments.
Second of all, contrary to the viewpoints advanced by Samuelson (1989) along

Malkiels three papers are as follows: Malkiel (2003), Passive investment strategies and Efficient Markets,
European Financial Management, Vol. 9, NO. 1, 1-10, Malkiel (2005), Reflections on the Efficient Market
Hypothesis: 30 Years later, The Financial Review 40, 1-9, and Malkiel (2003), The Efficient Market Hypothesis
and its critics, CEPS working paper, NO. 91. Princeton University.

65

with a majority of other economists, performance on the part of investors who have
consistently obtained abnormal returns does not mean that they have relied on sheer
luck. Rather, they have depended upon their knowledge of the stock market and
investment techniques.
Research conducted by the present writer indicates that, if an investor can
provide scientific description of the actual investor behavior, he will then stand a 20%
chance of being able to obtain abnormal returns on a continuing basis. If an investor
can provide a scientific description of the actual investor behavior and stock price
behavior, he will then have a 40% chance of being able to obtain abnormal returns on
a consistent basis. If an investor can not only provide a scientific description of the
actual investor and stock price behavior, but also define the interrelationship between
the actual investor behavior and stock price behavior, he will then stand a 60% chance
of being able to attain abnormal returns on an on-going basis. If an investor can not
only provide a scientific description of the actual investor and stock price behavior,
but also define the interrelationship between the actual investor behavior and stock
price behavior, and, at the same time, he has a scientific understanding of the stock
pricing process, he will then stand a 80% chance of being able to attain abnormal
returns on an on-going basis.
Lastly, the present writer has paid special attention to deciphering the works by
the great investment guru W. D. Gann.
42
W. D. Ganns work demonstrates beyond
any shred of doubt that W. D. Gann has not relied on luck to emerge successful during
his illustrious 50-yeaer career in the Wall Street. Rather, he has depended upon his
professional expertise and transaction techniques accumulated and matured over 50
years of practice in the Wall Street. W.D. Gann has not only been able to provide
scientific description of the investor behavior and stock price behavior, but also
provided scientific representations of the mutual relationship between the actual
investor behavior and stock price behavior. At the same time, this great investor has
had highly scientific insights into the process of stock price formation.
The present writer has also gone through and studied almost all the famous
writings and speeches delivered by George Soros since 1987. George Soros writings
and speeches tell us in a crystal-clear way that, like the great investment guru W. D.
Gann, George Soros not only can provide a scientific description of the actual investor
behavior and stock price behavior, but also can describe the mutual relationship

42
Concerning introduction to W. D. Gann works, please visit www.wdgann.com for details.
66

between the actual investor behavior and stock price behavior in a scientific fashion.
At the same time, this great investor has obtained a thoroughly scientific
understanding of the process of the stock pricing. It goes without saying, therefore,
that George Soros has not relied upon luck and instincts in achieving successes to date.
It should be noted that, these successful investors place emphases on different time
interval of the stock price behavior. In the case of W. D. Gann, his focus has been
laid on the short-term stock price behavior. In the case of George Soros, the main
point of attention has been the middle-term stock price behavior. In the case of
Warren Buffet, the main concern has been the long-term stock price behavior.
Knowledge and techniques on the part of the successful investor can be
duplicated and transferred
Research work conducted by the present writer has shown that the knowledge
and techniques possessed by these successful investors, like other forms of human
knowledge and technology, can be duplicated and transferred. Regrettably,
irrespective of W. D. Gann or George Soros or any other successful investors, they are
simply not willing to systematically and succinctly make their investment knowledge
known to all. As the investors investment techniques are formed on the basis of the
investment knowledge, insofar as the transfer of their investment knowledge is
concerned, it would be a lot harder for the investors to transfer investment techniques
to posterity.
Investors knowledge may be regarded as a group of schemas
43
or models.
These schemas represent the summary and distillation of the rules governing the
stock market behavior (including the investor behavior and stock price behavior) as
well as interactions between the investor and the market. The investors schemas
mainly cover three aspects: schemas description of the stock market behavior,
schemas forecast of the future stock market behavior and schemas rules of the
investors themselves. Investors investment techniques are actually based on these
schemas whereby specific circumstances of the real-life stock market are integrated
to form the proper investment strategies.
Obviously, if the investor is willing, their schemas may be very easily transferred
to other investors for the simple reason that these schemas are summaries of general

43
For detailed explanations on schema, please refer to Murrey Gell-Manns famous book Quake and J aguar
Rendezvous of Simplicity and Complexity. See Chapters 2 and 3.
67

rules of investor knowledge. This is very much like a world chess champion
transferring knowledge to a young chess player. However, if an investor is to
transfer investment techniques to a green hand, the task becomes much harder. The
reason is that, in the event of an investor wishing to transfer his/her investment
insights to a green hand, he/she must help the green hand to establish an investment
technique system that suits his/her own individual characteristics. That is to say, the
investor shall use his own investment knowledge, viz. schema-based knowledge, to
present and demonstrate to the green hand how to apply the schemas to the actual
stock market with the actual stock market information taken into full account.
Through such practical demonstrations and transactions in relation to the green hand,
the green hand will be able to form his unique investment technique system.
This is very much like a world chess champion coaching the young chess player
through actual chess games played. A new chess player needs to skillfully master at
least tens of thousands of actual chess games before he is able to reach the level of a
world champion. In the case of investor coaching, an investors investment
techniques must be practiced hands-on thousands upon thousands of times before
turning into a full-fledged investor in his own right. During the process, good
investment strategies are upgraded and retained, whereas shoddy ones are discarded
or refined. Undoubtedly, if an investor wishes to transfer his investment techniques
to a green hand, he will exert major efforts in terms of time and money.
For reasons known to all, it is extremely difficult for us to find a successful
investor who is ready and willing to expend large amounts of time and energy to
transfer his own investment techniques to a green hand. We can, however, envision
the following scene: almost every successful investor is ready to spend vast amounts
of time and energy transferring his know-how to the investors all over the world
through publishing their writings, although writings by many a successful investor
are notoriously obscure and hard to follow, such as the writings of W. D. Gann and
George Soros.
By summing up the above conclusions, we can see that the investment
performance on the part of successful investors has not come from sheer luck.
Rather, they owe their success to their knowledge and technology. The knowledge
and techniques on the part of the successful investors can be duplicated and
transplanted. However, for reasons known to all, not a single successful investor
has been willing to transfer his own unique investment techniques.
68

7.2 Fama (1998)
Fama (1998, p. 25) concludes:
The recent finance literature seems to produce many long-term return anomalies.
Subjected to scrutiny, however, the evidence does not suggest that market efficiency
should not be abandoned. Consistent with the market efficiency hypothesis that the
anomalies are chance results, apparent overreaction of stock prices to information is
about as common as under-reactionmost important, the long-term return anomalies
are fragile. They tend to disappear with reasonable changes in the way they are
measured.
In this section, the present writer will use his research achievements as basis to
perform a comparative analysis between two groups of Behavioral Finance Scholars
research findings which listed in Famag 1998and Famas research conclusions.
Research findings by the behavioral finance scholars
DeBondt and Thaler (1985) find that when stocks are ranked on 3- to 5-year past
returns, past winners tend to be future losers, and vice versa. They attribute these
long-term return reversals to investor over-reaction. J egadeesh and Titman (1993)
find that stocks with high returns over the past year tend to have high returns over the
following three to six months. They attribute this to the momentum effect.
Fama (1998) research conclusions
Confronted with the challenge of the above behaviorist financiers, Fama (1998, p.
5) asserts that:
The market efficiency hypothesis offers a simple answer to this
question---Chance. Specifically, the expected value of abnormal return is zero.
But chance generates apparent anomalies that split randomly between over-reaction
and under-reaction.
Viewpoints of the present writer
Research performed by the present author has demonstrated that:
First of all, the stock price patterns identified by DeBondt and Thaler (1985) and
69

J egadeesh and Titman (1993) exist in large quantities in any stock market.
Irrespective of DeBondt and Thaler (1985) findings or J egadeesh and Titman (1993)
findings, we can easily observe them in actual stock markets, so they are not chance
results as asserted by Fama (1998). However, their findings must undergo the
process of scientific systemization before application to the stock market by the
investor.
Second of all, it is not really difficult to provide reasonable explanations on the
DeBondt and Thaler (1985) and J egadeesh and Titman (1993) findings if we have a
scientific stock pricing model which could describe accurately the actual stock price
behavior.
Lastly, J egadeesh and Titman (1993) findings and DeBondt and Thaler (1985)
findings are not the same thing.
J egadeesh and Titman (1993) findings are that, insofar as the fundamental factors
are not taken into account, the stock expected value can be put into the picture. In
other words, the stock provides possible tips on the future stock price movement.
Therefore, their findings are not a stock price movement pattern. J egadeesh and
Titman (1993) findings also exist in masse in the annual, quarterly, monthly, weekly
and daily historical figures associated with the stock price.
The finding by DeBondt and Thaler (1985) represents a kind of stock price
patterns that have not gone through the scientific and systematic process. Such stock
price pattern not only exists in the annualized stock price figures, but also exist in the
quarterly, monthly, weekly and daily price figures. Such stock price pattern along
with the follow-on stock price change exhibits a very important feature, which, to put
it in simple terms, if a real-life stock price sequence contains such a pattern, then the
possibility of the follow-on stock price movement in the reverse direction stands at
80%.
Regrettably, their explanations of such significant findings are wrong.
44
As the
behavioral finance essentially continues to use the standard financial theories
analysis frameworks, and the standard financial theories along with their analysis
frameworks are unfortunately unscientific, the above-mentioned scholars just cannot
provide any scientific explanations on the stock behavior that they have observed.
Because of the same reason, it is not difficult for us to comprehend why Michaely,
Thaler and Womack (1995, p. 606) writes:

44
For a better understanding of the unscientific nature of Behavioral Finance, please refer to the present writers
paper On the Investor Behavior and Stock Price Behavior.
70

We hope future research will help us understand why the market appears to
overreact in some circumstances and under-react in others.
Commentary
In Fama (1991, p. 1577), Fama proclaims that:
The market efficiency literature should be judge on how it improves our ability
to describe the time-series and cross-section behavior of security
returnsNevertheless, judge on how it has improved our understanding of the
behavior of security returns, the past research on market efficiency is among the most
successful in empirical economics, with good prospects to remain so in the future.
If the above criterion regarding evaluation of EMT is used to assess Fama (1998)
conclusions, then the conclusion can only be that EMT not only fails to strengthen our
understanding of the actual stock price behavior, but also misleads us. Explanations
from Fama (1998) are entirely wrong.
7.3 Malkiel (2003) and (2005)
Malkiel (2003, p. 2) writes the following:
Indexing is a sensible strategy because our security markets appear to be
remarkably efficient in digesting and adjusting to new information.
Malkiel (2005, p. 2) writes that
The strongest evidence suggesting that markets are generally quite efficient is
that professional investors do not beat the marketIf prices were often irrational and
if market returns were as predictable as some critics of the efficient market hypothesis
believe, than surely actively managed investment funds should easily be able to
outdistance a passive index that simply buys and holds the market portfolio.
In this sub-section, the present writer will make a brief commentary on Malkiel
(2003) and (2005) viewpoints.
Commentary on Malkiel (2003) research conclusions
The fact that Malkiel (2003) conclusions are rational is predicated on a crucial
assumption: the stock market is efficient.
From the past to the present time, performance on the part of an overwhelming
71

majority of institutional and individual investors have indeed never been able to beat
the stock price index. The indexing strategy derived from the conclusions of EMT
and CAPM. Research by the financial academic circle within the past 30 years has
proven that indexing strategy is a useful investment strategy. However, as the
present writer has elaborated earlier, the random walk model and EMT are all
mistaken theories. Consequently, the assumptions associated with Malkiel
conclusions are simply not feasible. As a result, conclusions drawn by Malkiel are
unacceptable. Obviously, the indexing strategy is a useful investment strategy not
because that the market is efficient, but for other reasons.
As EMT analysis framework is unscientific, EMT theorists inevitably had errors
with their cognition of the situation. They have regarded indexing as the only
rational investment strategy available to the investor. As a result, the indexing
strategy has been over-used to the extreme. A simple fact is that, irrespective of the
past or the present, as long as the market is one of real-life stock market including the
burgeoning stock market in China, indexing is certainly a useful strategy.
Indexing is a useful investment strategy for the investor is because of the
following reason. Currently, any one of the stock markets is slowly evolving
towards the human idealized stock market. Irrespective of the burgeoning stock
market in China or the matured US stock markets with a history of over 100 years or
the European stock markets, we can clearly identify plenty of evidence pointing to the
stock index rising rather than falling. As all stock markets embody human
aspirations to dash towards the ideal stock market of the investors, in the distant
future, the stock price rising more than falling would become a model of only rising
and never falling. The investor aspirations inherent in the stock markets all over the
world make the stock price rising more than falling and this would lead to the
situation where indexing strategy would be a useful investment strategy.
However, indexing strategy is not the optimal investment strategy, and far from
the only scientific investment strategy, the reason is that, although all stock markets
evolve towards human aspirations, the velocity of such evolution is really too slow,
with wild ups and downs in the process. To illustrate with the J apanese stock market
as a case in point, since its peak in 1990, the market has stayed at a trend of decline.
In 2003, the J apanese stock market began to rebound and rise. If the investor had
applied the indexing strategy to invest in the J apanese market in 1990, his loss could
have been enormous.
72

Commentary on Malkiel (2005) research conclusions
Malkiel (2005) correctly pointed out that professional investment managers
could outperformed their index benchmarks in a period of 4 years when return is
measured over a time-interval of 10 years, over 80% of active managers are
outperformed by the index. When returns are measured over a period of 30 years,
few active managers could outperform the index.
First and foremost, plausibility of Malkiel (2005) conclusion is predicated on one
critical assumption to the effect that stock price movements approximate those of a
random walk. Earlier, the present writer has already discussed that the random walk
theory and EMT are both mistaken theories. As Malkiels assumption cannot stand,
his conclusions are unacceptable as well.
Under the following two scenarios, the stock market (index) is unbeatable: firstly,
stock price movement is real random sequencing. As a famous scholar once put it,
the randomness could be defined as invincible. This accounted for the root cause of
the earnings of the insurance company and the gambling houses. Secondly, the
stock price only increased and never decreased. Under such two scenarios, the best
strategy on the part of the investor is buy and hold low-cost broad-based index fund
that holds all the stocks comprising the market portfolio, or resorting to the passive
management. That is to say, only when the stock market approaches the nearly
idealized state (the stock price only increased and never decreased) or the stock price
sequence is of the real random time sequence, the market is invincible. So the best
policy for the investor is to buy and hold. But the actual stock price behavior is just
inconsistent with the definitions of random walk model and EMT. Currently, the
stock price experiences both rises and falls. In recognition of this, irrespective of
theory or practice, we can beat the real-life stock markets. Warren Buffet and
George Soros are best test cases.
Secondly, Malkiel (2005) interprets the statistical results of fund investment
returns as evidence supporting EMT. Such practice is clearly unacceptable. The
reason is that he has ignored a critical question, viz. the physiological limit of human
foresight of the future. Theoretically speaking, a person can only form the
expectations of the future stock price of any statistical significance less than 7 unit
time. In real-life situations, as the market is filled with mutually contradictory
information, a person can normally form the expectations of the future stock price of
73

any real statistical significance covering 1-3 unit time. The performance of the fund
manager is predicated on his expectations of the future trend of the stock price
movement. Unfortunately, the fund manager is not God, and he normally could only
provide expectations of the future stock price of any real statistical significance valid
for 1-3 unit time. Specifically, Mutual and pension funds own about half of all
equities and account for an even larger percentage of all trading. It would hardly be
surprising that institutions on average fail to beat the market when they very nearly
are the market. (Lynn A. Stout, 2005). Consequently, we can easily understand why
the fund manager can beat the market (index) within 1-3 years, but invariably finds it
difficult to beat the market (index) within 10-30 years.
The time gaps for Malkiel (2005) statistical results are 10 and 30 years.
Obviously, such gaps have far exceeded the physiological limits of human brains.
On the crucial question of which time gap should be adopted to measure up the fund
managers investment performance, EMT theorists have simply not given any slight
consideration of the very existence of limits for human brains.
7.4 Malkiel (2003)
Malkiel (2003, p. 34) makes the following summarys
The market cannot be perfectly efficient or there would be no incentive for professionals to
uncover the information that gets so quickly reflected in the market prices, a point stressed by
Grossman and Stiglitz (1980)Periods such as 1999 where bubbles seem to have existed at
least in certain sectors of the market, are fortunately the exception rather than the rule. Moreover,
whatever patterns or irrationalities in the pricing of individual stocks that have been discovered in
a search of historical experience are unlikely to persist and will not provide investors with a
method to obtain extraordinary return.
Concerning Grossman and Stiglitz (1980)
45
This paper is by far the most influential among the series of papers by Grossman
and Stiglitz dealing with the stock market. Grossman and Stiglitz (1980, p. 404-405)
correctly points out the inherent inconsistencies in terms of logical deduction with the

45
According to Grossman and Stiglitz (1980), the authors intentions are as follows: We are attempting to redefine
the Efficient Market notion, not destroy it. In Grossman and Stiglitz (1982), the two authors stated the purpose
of the paper as follows: The goal of our paper was to show that when information is costly, a perfectly
competitive equilibrium will not exist which completely transmits the informed traders information to uniformed
traders.


74

EMH:
We show that when the efficient markets hypothesis is true and information is
costly, competitive markets break downBecause information is costly, prices cannot
perfect reflect the information which is available, since if it did, those who spent
resources to obtain it would receive no compensation. There is a fundamental
conflict between the efficiency with which market spread information and the
incentives to acquire information
EMH advocates almost unthinkingly transplants the conclusions of the above
paper to EMH. For example, Fama (1991, p. 1575) writes the following:
A precondition for this strong version of the hypothesis is that information and
costs, the costs of getting prices to reflect information, are always 0 (Grossman and
Stiglitz (1980))Since there are surely positive information and trading costs, the
extreme version of the market efficiency hypothesis is surely false.
Now the issue is: although Grossman and Stiglitz (1980) theoretically pointed
out that it is impossible for perfect efficient markets to exist, Grossman and Stiglitz
(1980, p. 393) outlines the stock market status and the relationship between investor
behavior and stock price behavior under this particular stock market status in the
following manner:
There is an equilibrium degree of disequilibrium: prices reflect the information
of informed individuals (arbitrageurs) but only partially, so that those who expend
resources to obtain information do receive compensationprices perform a
well-articulated role in conveying information from the informed to the
uniformedthus the price system makes publicly available the information obtained
by the informed individuals to the uniformed. In general, however, it does this
imperfectly; this is perhaps lucky, for were it to do it perfectly, an equilibrium could
not exist.
Is the above description a close approximation of the actual stock market realities?
And the more crucial issue is that: is it possible for the stock market status described
in Grossman and Stiglitz (1980) to provide substantive support to the efficient
market theorists new assertion that the stock market is just remarkably efficient?
Research work performed by the present author demonstrates that, unfortunately,
the answers to the above two issues are negative.
As the paper lacks scientific understanding of the actual investor behavior and
stock price behavior along with the interrelationship between both, plus the lack of
75

scientific content in the basic elements of the other analysis frameworks (such as
equilibrium and Rational Expectations etc.), the stock market status described by
Grossman and Stiglitz (1980) in terms of competitive equilibrium and the
interrelationship between the investor behavior and stock price behavior under this
particular status is far from a rational approximation of the stock market realities. In
fact, the stock market status and the interrelationship between the investor behavior
and stock price behavior under this particular status is a totally absurd description of
the actual stock market realities.
To provide a scientific description of the actual stock market status, we must
meet the following three conditions. The first condition is that we must be able to
perform a scientific description of the actual investor behavior and stock price
behavior along with their mutual interrelationship. The second condition is that we
must be able to have a scientific understanding of the stock pricing process in the
stock market. The third condition is that we must have a scientific understanding of
the nature of the stock market. As a matter of fact, only by meeting all of the
foregoing three conditions is it possible for us to provide a scientific description and
explanation of the actual stock market status and the interrelationship between the
investor behavior and stock price behavior under actual stock market status.
First of all, we need to examine whether Grossman and Stiglitz (1980) can
scientifically describe the investor behavior.
In Grossman and Stiglitz (1980), investors are divided into two categories, viz.
one the informed trader and another the uninformed trader. According to Sanford
Grossman (1976, p. 573):
Informed traders learn the true underlying probability distribution which
generates a future price, and they take a position on the market based on this
information, and chances are that uninformed traders invest no resources in collecting
information, although they know that current prices reflect the information of
informed traders. Uniformed traders form their beliefs about a future price from the
information of informed traders which they gather from observing current prices.
If we compare the above description with the description in Section 2 concerning
the actual investor behaviour, we can easily identify that, irrespective of the informed
trader or uninformed trader, their actions are not scientific descriptions of the actual
investor behaviour. In the said paper, the investor is assumed to have Rational
Expectations. In Section 6 of this paper, the present writer has already stated that the
76

theory of Rational Expectations is not a scientific theory. Besides, in the paper, the
investor is assumed to be the price taker. In reality, the investor is not only a price
taker, but also a price shaper.
46
The authors of the paper has used the traditional
economic analysis practice to assume that the investor is only the price taker is not
only unscientific, but also has made it impossible for us to understand the relationship
between the investor behavior and stock price behavior in the stock market.
Obviously, the investor behavior portrayed by the paper is totally inconsistent with
that of the actual investor.
Second of all, let us examine whether the paper can be used to scientifically
capture the relationship between the investor behavior and stock price behavior.
In the eyes of the earlier economists and economists of later generations (such as
the authors of the foregoing paper), stock price itself does not constitute information.
Stock price is but the carrier of information. As a result, according to Grossman and
Stiglitz (1980), we can see a significant amount of statements regarding prices
transmitting information as well as prices revealing information and so on and so
forth. The issue in this respect is: are these statements scientifically based? Are
they scientific descriptions of the stock price behavior? To our regret, because of the
following three reasons, the answer is negative.
(i) In Section 2 of the present paper, the present author has already mentioned
that, only on the basis of having obtained a scientific understanding of the investor
behavior is it possible for us to proceed with scientific descriptions of the actual stock
price behavior along with the interrelationship between the investor behavior and
stock price behavior. The above analysis leads inevitably to the conclusion that
Grossman and Stiglitz (1980) lack scientific understanding of the investor behavior.
Consequently, the paper lacks a scientific basis for describing the stock price
behavior.
(ii) Fundamentally speaking, as the investor aspirations, expectations and logic
are embodied in the stock price movement sequences, the stock price itself is a kind of
inherent general information. Such inherent general information provides a
yardstick for measuring up the stock price behavior. Both the economists of earlier
and later generations (such as the authors of the foregoing paper) simply lack
scientific understanding of the foregoing inherent information associated with the
stock price.

46
In The alchemy of Finance and Open Society, George Soros provides very scientific description of the investor
behavior.
77

(iii) From the standpoint of the process of the formulation of future stock price
expectations on the part of the investor, at the early stage of the human brains forming
the expectations of the future stock price, the external information being input is
rather limited. Moreover, the demand on the quality of the external information is
rather stringent. As a result, only the external information conforms to the
physiological characteristics of the human brains can manage to make its way into the
stock price expectancy system of the human brains. As the overwhelming majority
of the external information simply does not match the physiological characteristics of
the human brains, during the course of the formulation of the future stock price, such
overwhelming majority of the external information just cannot enter the stock price
expectancy system of the investor. The overwhelming majority of the external
information actually makes it way into the expectation system that is independent of
the stock price expectation system on the part of the investor. After going through
the processing of the investors expectation and cognition systems, what the investor
eventually gets is no longer the expected values of the external information. Rather,
it is qualitative rather than quantitative assessment on the future stock price on the
basis of the expected values of the foregoing information. Such assessments along
with the three expected values of the future stock price jointly make their way into the
investors decision-making system.
Summing up the above three points, we can easily draw up the following
judgment: irrespective of the statements such as prices transmitting information and
prices revealing information by Grossman and Stiglitz (1980) or Famas classical
allegation (stock prices reflect all the available information), they all lack scientific
connotations, and the statement in the paper that prices reflect the information only
partially is not supported by any scientific evidence.
Lastly, as the paper cannot meet even the first and second terms of the above, it
certainly cannot meet the third condition. That is to say, we cannot realistically
expect the stock market status along with the interrelationship between the investor
behavior and stock price behavior under the foregoing status as described by
Grossman and Stiglitz (1980) to be a close approximation of the actual stock market
realities. As a result, research conclusions by Grossman and Stiglitz (1980) are not
adequate for the purpose of providing any substantive support for EMH in its revised
and improved-upon form.
It should be noted that, although Grossman and Stiglitz (1980) points out the
78

logical absurdities with EMT, the conclusions of their paper have fallen far short of
shaking the foundations of EMT, and have provided EMT proponents with a good
excuse to resort to in case of need. For example, when the connotations or forecast
of EMT are found to be inconsistent with the stock market realities, the EMT theorists
would use pretexts such as claiming that the market is not fully efficient or that the
market is only remarkably efficient to ward off the major impacts exerted on EMT by
the stock market.
Stock price patterns
To provide scientific responses to a full array of questions including whether the
stock price patterns exist due to data mining, whether the stock market patterns exist
on a long-term basis, whether the stock price patterns would involve self-destruction,
and whether the stock price pattern can be used to earn dependable abnormal returns
etc., we must obtain scientific understanding of the investor behavior and stock price
behavior.
In Sections 2 and 6 of this paper, the present writer has already dealt with the
conclusions associated with the market closure data spanning over 102 years for the
DJ IA and the stock price patterns in general. The present writers research has
demonstrated that the stock price patterns discovered by financial economists, such as
long-term reversal pattern and short-term momentum pattern, not only exist on a
long-term basis, but also exist in all the historical data sequences of any one single
stock market all over the world. For this reason, the allegation by EMT theorists that
such stock price patterns are attributed to data mining is totally unscientific.
To scientifically classify the stock price patterns requires special techniques, it is
necessary to recall that any one actualized stock price pattern represents the
combination of the investor ideals, pattern of the investor anticipation of the future
and fundamental factors. At the same time, every kind of actualized stock price
pattern has minor shades of difference in terms of magnitude. As a result, even
though the same kind of stock price pattern appears repeatedly in front of the investor,
it is impossible for the investor to rely on his vision and experience to discern the
involved stock price patterns provided that he does not possess the specialist skills
required for scientific classification of the stock price patterns. To make matters
worse, as the total amount of the kinds of stock price patterns far exceed the very
limits of human memory and processing in the brains at a given unit time, when
79

different kinds of stock price patterns mix up and appear before the investor, it is just
impossible for the investor to recognize the involved stock price patterns provided he
does possess the scientific cognition of all the stock price patterns.
The present writers research has also demonstrated that, normally, a 5-year-long
stock price historical sequence with the transaction day as the time interval contains
all the patterns of the stock price movement. On average, every 30 units time (such
as daily, weekly, monthly and annual) data of the stock price contain around 4 stock
price patterns; the consecutive price data (not rate of return) at every 60 units time
contains the pattern of movement of stock price repeating itself once. An obvious
fact of the matter is that, since 1998, the DJ IA annual data has maintained operations
at the same price pattern on two separate occasions.
By integrating the above conclusions with our discussion on whether EMT is a
close approximation of reality in Section 6, we are in a position to identify that
Malkiels allegation that many of these patterns, even if they did exist, could
self-destruct in the future is simply lacking in scientific evidence.
Is it possible for the investors to make use of these stock price patterns to form
investment strategies to earn abnormal returns in a reliable manner? The answer is
both affirmative and negative at the same time. As the present writer has already
dealt with this subject matter in Section 6 and this particular sub-section, the present
writer is not prepared to repeat in this particular context right now.
It should be noted that, irrespective of Lo, Mamaysky and Wang (2000) or the
behavioral finance proponents, such as DeBondt and Thaler (1985), the involved
stock price patterns have not undergone any scientific systemization process. If we
cannot perform any scientific classification on these stock price patterns, it is then
impossible for investors to rely on these patterns to obtain abnormal returns in a
reliable manner. By integrating the present authors discussion in Section 6 with this
sub-section, we can easily understand why Richard Roll complains in the following
way:
I have personally tried to invest money, my clients money and my own, in
every single anomaly and predictive device that academics have dreamed up. I have
attempted to exploit the so-called year-end anomalies and a whole variety of strategies
supposedly documented by academic research. And I have yet to make a nickel on
any of these supposed market inefficiencies.
47


47
See Malkeiel (2003), p. 23-24. Quotation.
80

Stock price bubble and stock market crash
The present writers analysis of the stock price patterns associated with the DJ IA
at the time of the crash of the stock market in 1987 reveals that, irrespective of the
annual data, quarterly data, monthly data, weekly data and daily data, they all gave
clear signals in the run-up to the crash of the stock market. The present writers
analysis on the price patterns associated with the three major stock price indexes
between 1990-2000 in the US stock markets indicates that, irrespective of NDXI,
S&P500 or DJ IA, they all displayed clear signals of falling of the stock price by the
end of 1999. Irrespective of the US stock market crash in 1987 or the falling of the
stock price in the US stock market at the beginning of 2000, they all boil down to one
single cause: the stock prices have been overly valued. And the major reason in this
respect is that: people lack scientific understanding of the actual investor behavior and
the mutual relationship between the investor behavior and the stock price behavior.
48
What deserves special mention is that, the movement patterns of the historical
figures of the DJ IA in 1987 not only look rather simple, but also very frequent in the
stock markets. In particular, the annual data, quarterly data and monthly data all
display regular patterns to such an extent that it is possible to draw the crash
conclusions by relying on simple technical analysis methodologies. Therefore, it is
not difficult for us to comprehend why Paul Tudor J onesL has been able to earn
good money through technical analysis methodology in the midst of the stock market
crash. Prior to the falling of the stock price in 2000, the patterns of movement of the
three principal stock markets in the US looks very rare in light of the annual figures.
Consequently, even the world-famous investment guru commits errors in judging the
market movement (as in the case of George Soros who began to sell short US shares
at the beginning of 1999).
In fact, irrespective of the movement patterns of the historical sequences of the
DJ IA at the time of US stock market crash in 1987 or the movement patterns of the
stock price index prior to the falling of the stock price in 2000, these patterns emerge
with great frequency in the daily historical price data of US stock markets and are also
widely seen in the daily historical price data of other major stock price index such as

48
To provide detailed explanations on these special stock price phenomena goes beyond the scope of the present
paper. For this reason, the present author has chosen to make but a brief mention.
81

HSI and FTSE and so forth. Consequently, we can say with assurance that
explanations offered by Malkiel (2003, p. 27-29) are unscientific.
It would be a mistake to dismiss the significant change in the external
environment, which can provide an entirely rational explanation for a significant
decline in the appropriate values form common stocksBut even here, when we
know after the fact that major errors were made, there were certainly no arbitrage
opportunities available to rational investors before the bubble poppedFortunately,
bubble periods are the exception rather than the rule and acceptance of such
occasional mistakes is the necessary price of a flexible market system that usually
does a very effective job of the allocation capital to its most productive uses.

8 Concluding Remarks
8.1 Summary
Errors with EMT can be summarized as follows:
Mistaken basis for ascertainment. EMT founding fathers have chosen the
observations and statistical conclusions drawn up by theorists of the random walk as
basis for ascertaining EMT. As a result, EMT is founded upon the wrong
ascertainment basis.
Mistaken research methodology and inappropriate analysis framework. EMT
theorists have carried forward the incorrect methodology associated with stock price
behavior analysis favored by the theorists of the random walk. Inappropriate
economic analysis framework is adopted to try to rationalize the seemingly
random-walk-like stock price behavior. However, theorists have never attempted to
perform any in-depth analysis on the series of unrealistic assumptions arising from the
economic framework, which would exert critical impact on the correctness of their
research conclusions. At the same time, theorists have totally ignored study of the
scientific connotations of the basic elements inherent in the economic analysis
framework. As a result, it is easy for us to see why the random walk model,
Martingale and Fair Game models are all not suitable for use in explaining the stock
82

price behavior.
Mistaken conclusions. All the statements on the stock price behavior by EMT
are highly unscientific. EMT proclamation that technical analysis is useless is
mistaken.
49
The conclusion drawn by EMT advocates that the investor cannot beat
the market is entirely wrong. Explanations provided by EMT theorists on the
findings of the behavioral finance scholars are totally erroneous.
EMT errors can be summed up as follows. EMT is by no means the reasonable
approximation of the stock market realities, and its scientific content is close to zero.
The reason is pure and simple: EMT absurdly describes the investor behavior, and
mistakenly describes and explains the stock price behavior. Furthermore, EMT
wrongly represents the inter-relationship between the investor behavior and stock
price behavior.
8.2 Commentary
Efficient market hypothesis is founded upon a series of unrealistic assumptions.
As these assumptions are simply unscientific in quintessence, from Fama (1970)
onwards, it has been rather difficult to ascertain EMT. Because of the
supplementation and revisions by Fama and other EMT theorists over a 20-odd-year
period, up to Fama (1991), EMT has become a financial theory that defies overturning
by facts.
50
A famous economist once put it well: in the entire scientific methodology
framework, the most important point is that it is possible for the theoretical
conjectures to be overturned by facts. A theory that defies overturning by fact is
simply never fit for clarification and explanation. In other words, science is not
tantamount to the pursuit of correctness or wrongfulness. What science aspires to
achieve is the possibility of being overturned by facts.
51
Although EMT theorists
have exerted tremendous efforts and energy in refining EMT theories, they are far
from enthusiastic about ascertainment of EMT, especially when the connotations of
EMT are jeopardized by empirical validations, EMT theorists invariably look for

49
Research carried out by the present author has proven that the core principles of Technical Analysis are correct.
Research has also proven the judgment of perceiving market and investor psyche through analysis of stock price
movement.
50
Fama (1991) proclaimed: Thus, market efficiency per se is not testable. (p. 1575)
51
WuChang, Zhang, Economics Explanations, Section Four: On Possibility of Being Overturned by Facts.
Quotation.
83

countless pretexts and excuses
52
or revise their theories in order to render the
validations ineffective. They are only interested in pursuing purely theoretical
studies, and are never enthusiastic about facing the validations of facts, which is
clearly contrary to the spirit of science.
53

Partly because of the foregoing unscientific practices, over the past 40 years,
EMT theorists have made scant contributions to the clarification and explanation of
the investor behavior and stock price behavior. Up to this point in time, EMT theory
cannot even provide correct answers to some basic questions. For instance, why are
there transactions between investors themselves? Why is the turnover of the stock
market so huge at this point in time and so on and so forth?
In the following sub-section, the present writer will quote the comments made by
three famous scholars, and, in the present writers opinion, they have grasped the core
of the issue under scrutiny.
(i) Edgar Peters mentioned in his Chaos and order in the capital markets that
EMT came into being under special circumstances when the actual stock price data
conflicted with their theoretical models. Through a critical assumption on the
mutual independence of the observations or rates of return within a single economic
frameworko the concept of rational investor and the efficient market hypothesis are
constructed to justify the application of the probability calculus. At last, EMT
conversely becomes the theoretical proof of the hypothesis that stock price follows a
random walk, although there are lots of empirical evidence showing that stock price
does not follow a random walk. Such practice has been referred to by Edgar E.
Peters as: Any scientist would complain that development of a theory to justify a
methodology is akin to putting the cart before the horse, which is terrible science.
54

(ii) Robert A. Haugen wrote in Chapter 10 of his The New Finance:
Overreaction, Complexity and Uniqueness that:
Financial economists, both Modern and Behavioral, dazzle themselves with
sophisticated mathematics. They gain much comfort in the intellectual rigor of the
methodologies.
It makes no difference if their assumptions are completely unrealistic, so long as

52
Such as data snooping and chance etc.
53
In Stigler, G.J (1950), (he pointed out that scholars lacking the enthusiasm about testing theories) G. J . Stigler
wrote: The criterion of congruence with reality should have been sharpened sharpened into the insistence that
theories be examined for their implications for observable behavior. Not only were such implications not sought
and tested, but there was a tendency, when there appeared to be a threat of an empirical test, to reformulate the
theory to make the test effective. Economists did not anxiously seek the challenge of the facts.
54
Peters, E., (1999). See p. 10 and 29. Quotation.
84

they parallel those made by their peers.
To them, elegance is all that matters. They look with disdain on the studies of
psychologists, sociologists, and anthropologists because their work seems so mushy in
comparison to their own. They dismiss, as unimportant, forces that may actually be
crucial but impossible to treat with mathematical rigor.
(iii) In an article entitled There is no Invisible Hand in The Guardian, J oseph
Stiglitz states that:
Last years laureates implied that markets were not, in general, efficient; that
there was an important role for government to play. Adam Smiths invisible
handthe idea that free markets lead to efficiency as if guided by unseen forces is
invisible, at least in part, because it is not thereThe Nobel Prize signifies how
important it is to study people and economies as they are, not as we want them to be.
Only by understanding better actual human behavior can we hope to design policies
that will make our economics work better as well.
55


55
The Guardian, Dec 20, 2002. Quotation.
85

Bibliography
Alexander, Sidney S., (1961: May), Price Movements in Speculative Markets: Trends or Random
walks, Industrial Management Review 7-26.
Alexander, Sidney S., Price Movements in Speculative Markets: Trends or Random walks. No. 2,
in In Paul Cootner (ed.), The Random Character of Stock Market Prices, Cambridge,
MA: MIT Press, 338-72.
Barberis, Nicholas and Richard Thaler, 2003, A Survey of Behavioral Finance, Forthcoming in the
Handbook of the Economics of Finance.
Bachelier, Louis, Theory of Speculation, In Paul Cootner (ed.), The Random Character of Stock
Market Prices, Cambridge, MA: MIT Press, 17-75.
Black, Fischer, 1986, Noise, Journal of Finance 41, 529-543.
Beaver, William H., 1981, Market Efficiency, The Accounting Review,Vol. LVI, No.1.
Bodie, Zvi, Alex. Kane and Alan J . Marcus, 1999 Investments, 4
th
edition, McGraw-Hill
Companies, Inc. USA.
Bodie, Zvi and Robert C. Merton, 2000, Finance, First edition, Prentice-Hall, Inc. USA.
Breeden, Douglas T., 1979, An intertemporal asset pricing model with stochastic consumption and
investment opportunities, Journal of Financial Economics 7, 265-296.
Campbell, Lo and Mackinlay, 1997, The Econometrics of Financial Markets, Princeton, NJ:
Princeton University Press.
Chan, Louis K. C., Narasimhan J egadeesh, and Josef Lakonishok, 1996, Momentum Strategies,
Journal of Finance 51, 1681-1713.
Cootner, paul, 1964, The Random Character of the Stock Market Prices (MIT Press, Cambridge,
MA).
Cootner, paul, (1962: spring), Stock Price: Random vs. Systematic Changes, Industrial
Management Review, 24-45.
Cowls, Alfred, 1934, Can stock market forecasters forecast? Econometrica, 1, 309-324.
Cowls, Alfred, 1944, Stock Market Forecasting, Econometrica 12, 206-214.
Cowls, Alfred, (October 1960), A Revision of Previous conclusions regarding stock price behavior,
Econometrica, Vol. 28, 4. 909-915.
Daniel, K., Hirshleifer D., and A. Subrahmanyam, (1998), Investor Psychology and security
Market under-and overreactions, Journal of Finance 53, 1839-1885.
86

DeBondt, Werner F. M., and Richard Thaler, 1985, Does the stock market overreact, Journal of
Finance 40, 793-805.
DeBondt, Werner F. M., and Richard Thaler, 1987, Further Evidence on Investor Overreaction and
stock Market Seasonality, Journal of Finance 42, 557-581.
Dunbar, Nicholas, 2002, The story of Long-term Capital Management and the Legends behind it,
(First edition of Chinese version), Shanghai, Peoples Press. P. R. of China.
Fabozzi, Frank J . Francis Gupta and Harry M. Markowitz, (Fall 2002), The Legacy of Modern
Portfolio Theory, The Journal of Investing, 7-22
Fama, Eugene F., 1965, The Behavior of Stock-Market Prices, The Journal of Business 38,
34-105.
Fama, Eugene F., and Marshall Blume, 1966, Filter Rules and stock Market timing, Journal of
Business 39(1), pp. 226-41
Fama, Eugene F., 1970, Efficient capital markets: A review of theory and empirical work, Journal
of Finance 25, 384-417.
Fama, Eugene F., 1976a, Foundations of Finance, NY: Basic Books.
Fama, Eugene F., 1991, Efficient capital market II, Journal of Finance, 46(5): 1575-1617.
Fama, Eugene F., 1992, The Cross-Section of Expected stock Returns, Journal of Finance, 47:
427-465.
Fama, Eugene F., 1998, Market Efficiency, Long-term Returns, and Behavior Finance, Journal of
Financial Economics 49, 283-307.
Fama, Eugene F.,and Kenneth R. French, 1992, The cross-section of expected stock returns,
Journal of Finance 47, 427-465.
Fama, Eugene F.,and Kenneth R. French, 1993, Common risk factors in the returns on stocks and
bonds, Journal of Financial Economics 33, 3-56.
Fama, Eugene F.,and Kenneth R. French, 1996, Multifactor explanations of asset pricing
anomalies, Journal of Finance 51, 55-84.
Friedman, M., and L. J . Savage, 1948, The Utility Analysis of Choices involving Risks, Journal of
Political Economy 56, 279-3-4.
Friedman, Benjamin M., 1979, Optimal Expectations and the extreme information assumptions of
Rational Expectations macromodels, Journal of Monetary Economics 5, 23-41
Gell-Mann, Maurray, 1994, The Quark and The Jaguar, (W.H. Freeman and Company Press).
Gilson, Ronald J ., and Reinier H. Krakman, 1984, The Mechanisms of Market Efficiency, 70
Virginia Law Review (May). 549-50.
87

Gordon, J ohn Steele. The Great Game: The emergence of Wall Street as a world power:
1653-2000, Chinese edition, CITIC Publishing House. P.R.of China.
Graham, B. and D. L. Dodd, 1934, Security Analysis, New York: McGrew Hill.
Granger C.W.J ., and O. Morgenstern, Spectral analysis of New York Stock Market Prices, Kyklos
16 (1963), 1-27. Also reprinted in Cootner, paul, 1964, TheRandom Character of the Stock
Market Prices (MIT Press, Cambridge, MA).
Grossman, Sanford J ., 1976, On the Efficiency of Competitive Stock Markets where traders have
diverse Information, Journal of finance (May)31, 573-85.
Grossman, Sanford J., and E. Stiglitz, 1980, On the impossibility of informationally Efficient
Markets, American Economic Review 70, 393-408.
Grossman, Sanford J., and E. Stiglitz, 1982, On the impossibility of informationally Efficient
Markets: Reply, American Economic Review, Vol. 72(4), pages 875.
Grossman, Sanford J ., 1981, An Introduction to the Theory of Rational Expectations under
Asymmetric Information, Review of Economic Studies, XL VIII, 541-559.
Hamilton, William, 1922, The Stock Market Barometer: A Study of its Forecast Value Based on
Charles H. Dows Theory of the Price Movement (Barrons, New York, NY.).
Haugen, Robert A., 1995, The New Finance: The Case against Efficient Markets, prentice Hall,
Englewood Cliffs, New J ersey.
Haugen, Robert A. (2004), The New Finance: Overreaction, Complexity and Uniqueness, 3
rd

Edition, prentice Hall, Upper Saddle River, New J ersey.
Hayek, F. A., 1945, The Use of Knowledge in Society, The American Review, Vol. XXXV,
Number 4.
J egadeesh, Narasimhan, and Sheridan Titman, 1993, Returns to buying Winners and selling losers:
Implications for stock market efficiency, Journal of Finance 48, 65-91.
J ensen, M C., 1978, Some Anomalous evidence Regarding Market Efficiency, Journal of
Economics 6: 95-101.
J ohn Maymard Keynes, 1936, The General Theory of Employment Interest and Money, Macmillan
and Co., Limited, London Chinese Version).
J ung, J eeman, and Robert J . Shiller, 2002, One Simple Test of Samuelsons Dictum for the Stock
Market, SSRN working paper series.
Kahneman, D. and A. Tversky, 1974, J udgment Under Uncertainty: Heuristics and biases, Science
185: 1124-1131.
Kahneman, D. and A. Tversky, 1979, Prospect Theory: An analysis of Decision Under Risk,
88

Econometrica 47:263-291.
Kahneman, D, and A. Tversky, 1981, The Framing of Decisions and the Psychology of Choice,
Science 211: 453-458.
Tversky, Amos, and Daniel Kahneman, 1986, Rational choice and the Framing of Decisions, The
Journal of Business, Vol 59, Issue 4, Part 2: The Behavioral Foundations of Economy
theory, S251-S278
Kahneman, D. and A. Tversky, 1992, Advances in Prospect Theory: Cumulative Representation
of Uncertainty, Journal of Risk and Uncertainty 5: 297-323.
Kendall, M. G., and A. Bradford Hill, 1953, The Analysis of Economic Time-Series-Part I: Prices,
Journal of the Royal Statistical Society, Series A, 116, 11-34.
Keynes, J ohn Maynard, 1936, The General theory of Employment Interest and Money, Macmillan
and Co., Limited London.
Knight, Frank H., 1921, Risk, Uncertainty, and Profit Hart, Schaffner & Marx; Houghton Mifflin
Company.
Lakonishok, J osef, Andrei Shleifer, and Robert W. Vishney, 1994, Contrarian investment,
extrapolation, and risk, Journal of Finance 49, 1541-1578.
LeBaron, Dean, (May/J une 1983), reflections on Market Inefficiency, Financial Analysts Journal
39, pp. 16-17.
LeRoy, Stephen F., (J une 1973), Risk Aversion and the Martingale Property of Stock Prices,
International Economic Review, Vol. 14, NO. 2, 436-446.
LeRoy, Stephen F., (March 1976), Efficient capital Markets: comment, The Journal of Finance,
Vol. 31, Issue 1, 139-141
LeRoy, Stephen F., (March 1982), Expectations Models of Asset \Prices: A Survery of Theory,
The Journal of Finance, Vol. 37, Issue 1, 185-217.
LeRoy, Stephen F., 1989, Efficient capital Markets and Martingales, Journal of Economic
Literature 27, 1583-1621.
Levy, Haim, 1996, Introduction to Investment, (Chinese Version) Peking University Press. P. R.
China.
Lo, Andrew W., and A. Craig Mackinlay, 1988, Stock market prices do not follow random walks:
Evidence from a simple specification test, Review of Financial Studies 1, 41-66.
Lo, A. W., and A. Craig Mackinlay, 1999, A Non-Random Walk Down Wall Street, Princeton:
Princeton University Press.
Lo, Andrew W., 2004, The Adaptive Markets Hypothesis: Market Efficiency from an
89

Evolutionary Perspective, Journal of portfolio Management, forthcoming.
Lo, Andrew W., 2005, Reconciling Efficient Markets with Behavior Finance: The Adaptive
Markets Hypothesis, SSRN working Paper series.
Lucas, Robert E., J r. 1972, Expectations and the neutrality of money, Journal of Economic Theory,
4 (April): 103-124.
Lucas, Robert E., J r. 1973, Some international evidence on output-inflation tradeoffs, American
Economic Review 63 (J une): 326-34.
Lucas, Robert E., J r. 1978, Asset Prices in an exchange economy, Econometrica 46 (November):
1429-45.
Malkiel, Burton, 1999, A Random Walk Down Wall Street: Including a Life-Cycle Guide to
Personal Investing (W. W. Norton, New York).
Malkiel, Burton, 2003, Passive investment strategies and Efficient Markets, European Financial
Management, Vol. 9, NO. 1, 2003, 1-10.
Malkiel, G. B., 2003, The efficient market hypothesis and its critics, CEPS working paper, NO. 91.
Princeton University.
Malkiel, Burton, 2005, Reflections on the Efficient Market Hypothesis: 30 Years later, The
Financial Review 40, 1-9.
Mandelbrot, Benoit, 1966, Forecasts of Future Prices, Unbiased Markets, and Martingale
Models, The Journal of Business 39, 242-255.
Markowitz, Harry, 1952, Portfolio Selection, The Journal of Finance 7, 77-91.
Michaely, R., Thaler R., and K. Womack, 1995, Price reactions to dividend initiations and
omissions, Journal of Finance 50, 573-608.
Miller, George A., 1956, The magical Number Seven, Plus or Minus Two: Some Limits on Our
Capacity for Processing Information, The Psychological Review, Vol. 63, pp. 81-97.
Mishkin, Frederic S., The Economics of Money, Baking, and Financial Markets, 6
th
edition. (New
York, N.Y.: Addison-Wesley)
Muth, J ohn F., 1961, Rational Expectations and the Theory of Price Movements, Econometrica,
Vol 29, Issue 3 (J uly): 315-335.
Niederhoffer, Victor, 1998, The Education of a Speculator, Chinese Edition (J ohn Wiley &Sons,
Inc).
Niederhoffer, Victor and M. F. M. Osborne, 1966, Market Making and Reversal on the Stock
Exchange, Journal of the American Statistical Association 61, 897-916.
Osborne, M. F. M, 1959, Brownian Motion in the Stock Market, Operation Research 7, 145-173.
90

Peters, Edgar, 1999, Chaos and Order in the Capital Markets, 2
nd
edition of Chinese version,
Economic Science Press, Beijing, P. R. of China.
Peters, Edgar, 2002, Fractal Market Analysis Applying chaos Theory to Investment and
Economics, 1
st
edition of Chinese version, Economic Science Press, Beijing, P. R. of
China.
Rhea, Robert, 1932, The Dow Theory, Barons, New York, NY.
Roberts, Harry V., 1959, Stock-Market Patterns and Financial Analysis: Methodological
Suggestions, The Journal of Finance 14, 1-10.
Rubinstein, Mark, 1975, Securities Market Efficiency in an Arrow-Debreu Economy, American
Economic Review (December).
Samuelson, Paul A. and William D. Nordhaus, 1998, Economics, 16
th
edition, McGraw-Hill
companies, Inc. USA.
Samuelson, Paul A., (1965:spring), Proof That Properly Anticipated Prices Fluctuate Randomly,
Industrial Management Reviewo 41-49.
Samuelson, Paul A., (Autumn, 1973), Proof that Properly Discounted Present Values of Asset
vibrate Randomly, The Bell Journal of Economics and Management Science, Vol. 4,
No. 2, 369-374.
Samuelson, Paul A., (1989:Fall), The judgment of economic science on rational portfolio
management: indexing, timing, and long-horizon effects, Journal of Portfolio
Management 16, 1; ABI/INFORM Global.
Savage, L.J ., 1954, The Foundations of Statistics, New York: Wiley.
Sharpe, William F., 1963, A Simple Model for Portfolio Analysis, Management Science 9,
277-293.
Sharpe, William F., 1964, Capital asset prices: a theory of market equilibrium under condition of
risk, Journal of Finance 19, 425-442
Sharpe, William F., Gordon J . Alexander and J effrey V. Bailey, 1995, Investments, the fifth
edition, Prentice Hall, Inc. USA.
Shefrin, Hersh, 2002, Beyond Greed and Fear Understanding Behavioral Finance and the
Psychology of Investing, Oxford University Press, Inc.
Shiller, Robert J ., 1981, Do stock prices move too much to be justified by subsequent changes in
dividends? American Economic Review 71, 421-436.
Shiller, R. J . (1987b), Investor Behavior in the October 1987 Stock Market Crash: Survey
Evidence, National Bureau of Economic Research Working Paper 2246.
91

Shiller, R. J ., 1990, Market Volatility and Investor Behavior, American Economic Review 80(2):
58-62.
Shiller, R. J ., 1995, Conversation, Information, and Herd Behavior, American Economic Review
85(2): 181-185.
Shiller, R. J ., 2000, Irrational Exuberance, Princeton University Press, New J ersey.
Shleifer, A, 2000, Inefficient Markets: An introduction to Behavioral Finance, Oxford University
Press.
Shleifer, A., and R. Vishny, 1997, The limits of Arbitrage, Journal of Finance 52, 35-55.
Shleifer, A., and R. Vishny, 1995, The limits of Arbitrage, NBER working paper NO. 5167.
Siegel, J .J ., 2003, What Is an Asset Pricing Bubble? An Operational Definition, European
Financial Management, Vol. 9, NO. 1, 2003, 11-24.
Smith, Adam, 1904, An Inquiry into the Nature and Causes of the Wealth of Nations, Fifth edition.
London: Methuen and Co., Ltd., ed. Edwin Cannan.
Smith, Adam, 1790, The Theory of Moral Sentiments, 6
th
edition, London: A. Millar.
Soros, George, 1987, The Alchemy of Finance, J ohn Wiley &Sons, Inc New York.
Soros, George, 2000, Open Society: Reforming Global Capitalism, Little, Brown and Company,
London.
Stout, Lynn, 2003, The Mechanisms of Market Inefficiency: An Introduction to the New Finance,
University of California, Los Angeles School of Law, Law & Economics Research Paper
Series ( http://ssrn.com/abstract=470161).
Stout, Lynn A. 2005, Inefficient Markets and the New Finance, University of California, Los
Angles School of Law, Law & Economics Research Papers Series
(http://ssrn.com/abstract=729224 )
Taqqu, Murad S., 2001, Bachelier and his times: A conversation with Bernard Bru, Finance and
Stochastics 5, 3-32.
Von Neumann, J ., and O. Morgenstern, 1944, Theory of Games and Economic Behavior,
Princeton: Princeton University Press.
Williams, J ohn Burr., 1938, The Theory of Investment Value, Fraser Publishing Company,
Vermont. USA.
Working, Holbrook, 1934, A Random-Difference Series for Use in the Analysis of Time Series,
Journal of the American Statistical Association 29, 11-24.



92