What Is the Alternative Hypothesis to Market Efficiency?

Abstract

On repeated occasions, Eugene Fama has claimed that critics have failed to offer a complete alternative to the efficient market hypothesis (EMH). Most notably, in his Nobel speech, Fama [2014] said, "Most important, the behavioral literature has not put forth a full blown model for prices and returns that can be tested and potentially rejected—the acid test for any model proposed as a replacement for another model." Here I argue that Fama's complaint is too strong. The EMH can fail, and there still be no model that meets Fama's criteria. This short article explains why this is so and offers a more reasonable alternative to the EMH based on the viewpoint that behavioral biases, though common, are state dependent.

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