Efficient market hypothesis questioned: What does this mean for collective intelligence?

Today's Financial Times discusses a recent study by the Chartered Financial Analyst Institute indicating that their members overwhelmingly disagree with the assertion that investors behave "rationally" and overwhelmingly agree that markets do not reflect all available information.

If rationality is not the basis for forming decisions in the market, then what is? George Akerlof and Robert Schiller, prominent economists (a Nobel prize winner and a Yale professor, respectively), have a recent book out arguing an alternative hypothesis: animal spirits. They, too, challenge the conventional wisdom of the efficient market hypothesis, instead offering the role of human psychology as the driving force behind most market decisions. Confidence, envy, temptations, resentment, and illusion were in fact the driving factors to the current economic crisis. In this interpretation, because people are not rational, the government needs to assert itself more aggressively in order to tame the animal spirits and restore order in the economy.

This theory is gaining traction with those seeking to explain seemingly irrational market swings. But if markets are not rational, what does this mean for collective intelligence and forecasting? If the role of "animal spirits" is true, can online markets characterized by transparency, community, and information sharing avoid some of the "unexplainable" and extreme market fluctuations?

Hat tip to Midas Oracle for the FT link.

Comments

[Mr. Econotarian]

Confidence, envy, temptations, resentment, and illusion were in fact the driving factors to the current economic crisis. In this interpretation, because people are not rational, the government needs to assert itself more aggressively in order to tame the animal spirits and restore order in the economy.

What is the driving factor behind government and politics besides confidence, envy, temptations, resentment and illusion?

Perhaps the amount of rationality in the markets is not 100%, but at least there is some rationality there...for government, what rationality is there, except the rational pursuit of campaign contributions, voters, and thus personal power?

[Melody]

Mr. Econotarian -- Your point is very well taken and I agree that is the major flaw of the argument. I've just about finished the book now and I have not seen one compelling reason why we should believe that governments will act more rationally than the public.