The efficient markets hypothesis has a hard time explaining behavior in real markets.
In theory, traders search for asset prices that are higher or lower than fair value and profit by arbitraging back to fair value.
But in real markets, rising prices encourage more buying, which drives prices even further from fair value. Falling prices encourage more selling, pushing prices lower still.
Markets don't price to what traders think is fair value. They price to what traders think other traders will think the price will be.[1]
We have reached the third degree where we devote our intelligences to
anticipating what average opinion expects the average opinion to be.
The very existence of persistent booms and busts debunks much of efficient markets theory, and consequently the illusion that free markets can regulate themselves.
[1] http://en.wikipedia.org/wiki/Keynesian_beauty_contest
In theory, traders search for asset prices that are higher or lower than fair value and profit by arbitraging back to fair value.
But in real markets, rising prices encourage more buying, which drives prices even further from fair value. Falling prices encourage more selling, pushing prices lower still.
Markets don't price to what traders think is fair value. They price to what traders think other traders will think the price will be.[1]
The very existence of persistent booms and busts debunks much of efficient markets theory, and consequently the illusion that free markets can regulate themselves.[1] http://en.wikipedia.org/wiki/Keynesian_beauty_contest