In an effort to broaden my horizons, I've started perusing the blog Marginal Revolution. (For the record, the reason I personally don't get too high-falutin here on Crash Landing is that that's what God invented mises.org for.)
Anyway, I was intrigued by the interview with Eugene Fama to which Cowen linked. But Fama says something pretty dumb, in commenting on the alleged "irrational exuberance" of markets:
Well, economists are arrogant people. And because they can’t explain something, it becomes irrational. The way I look at it, there were two crashes in the last century. One turned out to be too small. The ’29 crash was too small; the market went down subsequently. The ’87 crash turned out to be too big; the market went up afterwards. So you have two cases: One was an underreaction; the other was an overreaction. That’s exactly what you’d expect if the market’s efficient.
Huh?! I hate when really sharp proponents of a worldview talk like this; you see Darwinians do it all the time. Contrary to Fama, if the market were efficient, then the underreaction of 1929 would have nothing to do with whether the response to the 1987 crash were too high or too low. Ex ante the response would be expected to be just right, and ex post there's no reason to think it would've been more likely to be an overreaction. (Well, strictly speaking, if it weren't symmetrically distributed about the mean of zero, even so that would have nothing to do with the underreaction in 1929.)
If Fama were right, that would mean from 1935 onwards, people who believed in an efficient market would say, "The next time the market crashes, there will be an overreaction. So let's buy halfway into the plunge and we'll make money for sure."
Does that sound like an efficient market?
NB: I am not saying that an efficient market implies no over- or underreactions. What I'm saying is that the errors aren't correlated. What Fama has done is say that equivalent of, "The roulette wheel came up black and then red, which is exactly what we would have expected from a fair casino."
Finally, it occurs to me that it's getting late, and I have been dealing with a cranky toddler. So maybe I shouldn't be so quick to lecture Fama on the EMH. Oh well, "prove me wrong kids, prove me wrong."