Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets

by Nassim Nicholas Taleb

Much of the thinking about the negative value of information on society in general was sparked by Robert Shiller. Not just in financial markets; but overall his 1981 paper may be the first mathematically formulated introspection on the manner in which society in general handles information. Shiller made his mark with his 1981 paper on the volatility of markets, where he determined that if a stock price is the estimated value of “something” (say the discounted cash flows from a corporation), then market prices are way too volatile in relation to tangible manifestations of that “something” (he used dividends as proxy). Prices swing more than the fundamentals they are supposed to reflect, they visibly overreact by being too high at times (when their price overshoots the good news or when they go up without any marked reason) or too low at others. The volatility differential between prices and information meant that something about “rational expectation” did not work. (Prices did not rationally reflect the long-term value of securities and were overshooting in either direction.) Markets had to be wrong. Shiller then pronounced markets to be not as efficient as established by financial theory (efficient markets meant, in a nutshell, that prices should adapt to all available information in such a way as to be totally unpredictable to us humans and prevent people from deriving profits). This conclusion set off calls by the religious orders of high finance for the destruction of t...