'High Priests' of Rational Markets Question Their Faith

Despite their long-held belief in the "wisdom of crowds" theory of market behavior, a recent poll of British financial analysts found that 77% “strongly” or “very strongly” disagreed that investors in aggregate behave “rationally,” reports the Financial Times.

William Goodhart, CEO of The Chartered Financial Analysts (CFA) Institute in the United Kingdom, said the survey of the group's UK members showed a new mood of “questioning” in the aftermath of the financial crisis. The FT suggests, however, that these doubts reflect a wider "intellectual swing" away from the efficient markets hypothesis, which holds that asset prices reflect all known information and can change quickly in the face of new information. Indeed, about two-thirds of the CFA members said they no longer believed that market prices reflected all available information.

But even assuming that all market participants have access to all the information needed to make a rational investment decision, there is no certainty that such decisions can't be overruled by strong emotions — such as fear or greed. Such emotions not only helped to lead America into the current economic crisis, but may also be helping to keep it there, according to a recent Knowledge at Wharton article titled, "Hope, Greed and Fear: The Psychology behind the Financial Crisis." The crisis began with a bubble, Wharton finance professor Richard Herring said in the article. "Bubbles occur when people are willing to buy something simply because they believe they can sell it for a higher price. [Bubbles] often have an aspect of mania."

More from Knowledge at Wharton on emotions and the economy:

We Are Smarter Than Me: How the Wisdom of Crowds Can Help Businesses Succeed

How Human Behavior Drives Investment Activity