ProzacMarket 31horizons. The patent dubiousness of these requirements recently has
become an important aspect of the literature criticizing CAPM.
The literature demonstrates that demand for particular stocks is
sensitive to price changes, just like demand for most other goods.^17
Investors have different appetites for particular stocks as their prices
change. Thus, markets do not depict the right price of a stock be-
cause there is no such thing. Even rational people are not homo-
geneous automatons; they interpret information differently, and their
judgment about the present value of a business’s future cash flows
will vary even if they are all rational.
As Francis Fukuyama has pointed out in another context, the
neoclassical economic model of rational self-interested behavior with
which EMT is ultimately linked is right only about 80% of the time.^18
Its devotees forget Adam Smith, the father of their thought, who
emphasized that economic life is embedded in social life and that
economic actors make decisions that vary from pure economic cal-
culus as a result of social habits and contexts. That is why in Smith’s
day his field was called “political economy” rather than, as it is today,
simply “economics.”
If the rest of social science should be returned to economics, it
is even possible to add some physics from the hard sciences. Recall
that the random wal kmodel got that name because public capital
markets seemed to obey the principles of Brownian motion, which
specify that molecules in motion behave randomly. Although mole-
cules lac ksentience, prices are strictly creatures of the ultimate sen-
tience, human behavior.
Common sense thus suggests that the price-molecule parallel
should not hold. More powerfully, current thought in physics con-
cerning nonlinear dynamics and chaos theory extends well beyond
Brownian motion and suggests further reasons to doubt and recon-
sider the validity of the analogy.
The next chapter shows how that analogy has been turned upside
down and inside out. Before going on, though, pause to consider
whether common sense supportsβas a measure of risk. Whatβ
really measures is the price volatility of a stock. If you insist on
associating the word “risk” with that measure, it at most means that
βcaptures the ris kof stoc kprice gyrations. For a mar ket analyst,
that measurement may be of some interest.
But for a business analyst, price gyrations are useless analytic
tools, and so therefore isβ. What matters in business analysis might
be called “business volatility,” the gyrations in earnings or cash flows