Justin Fox's "The Myth of the Rational Market"

This was an excellent book. I finished it and started it again. It is worth reading twice.

This covers economic & finance theory from the end of the 19th century up to today. The main focus is on how economists fall in love with their models and over time ignore the "fine print" warning that the model is just a model and end up really believing in "homo economicus" (the perfectly rational economic agent) and that markets are "efficient". The theory ignores that we are weak in logic, limited in our data retention and analysis capabilities, and subject to herd mentality. The book documents how these psychological and behavioural aspects were overlooked in pursuit of grand theories (physics envy, the economists & finance professors wanted the same glorious simple equations that physicists obtain, but physics is about blind particles and forces, people communicate, people have emotions, that got lost in the theorizing). In the end Justin Fox states that he believes the theorists will again build castles in the air until the next big crash. As theorists they can't control their theorizing.

Here's a nice summary of what the book is about:

I went back to New York and wrote my article. ("Is the market rational?" the headline read. "No, say the experts. But neither are you -- so don't go thinking you can outsmart it.") It grew into this book, and during my years of working on it I've continued to struggle with what to make of the conflicting but not diametrically opposed worldviews of Fama and Thaler.

That is the final thrust of the book but it gives the impression that he works both sides of the street. No. About 90% of the book is concerned with the "efficient market" theorists and only 10% talks about behavioural economics. Even this leaves the wrong impression because he sees behavioural economics as an immature science with no grand theory. On the other hand, the efficient market crowd has a wonderful overarching theory. The only problem: the theory rests on demonstrably false assumptions and it can't account for the economic panics and crashes like 2008.

If you want to get on a first name basis with all the important theorists and get a passably good understanding of their basic ideas, this is the book for you. It is a real who's who. Here's Fox's pitch:

This book offers no grand new theory of how markets truly behave. It is instead a history of the rise and fall of the old theory -- the rational market theory. It is a history of ideas, not a biography, or even a collection of biographies. But it is full of characters -- most of the economists and finance professors -- who were actors in many of the great dramas of the twentieth century, from the 1920s boom to 1930s Depression to war and then peace and prosperity, then the 1960s book and the 1970s bust and so on.