The spectacular rise of US stock-market prices in the technology sector over the past few years and the even more spectacular crash last year has intensified the well-worn controversy surrounding the rationality of investors. Most financial economists are advocates of the “Efficient Markets Hypothesis” (Samuelson, 1965) in which prices are determined by the competitive trading of many self-interested investors, and such trading eliminates any informational advantages that might exist among any members of the investment community. The result is a market in which prices “fully reflect all available information” and are therefore unforecastable.

Critics of the Efficient Markets Hypothesis argue that investors are often if not always irrational, exhibiting predictable and financially ruinous biases such as overconfidence (Fischoff & Slovic, 1980; Barber & Odean, 2001; Gervais & Odean, 2001), overreaction (DeBondt & Thaler, 1986), loss aversion (Kahneman & Tversky, 1979; Shefrin & Statman, 1985; Odean, 1998), herding (Huberman & Regev, 2001), psychological accounting (Tversky & Kahneman, 1981), mis-calibration of probabilities (Lichtenstein, Fischoff, & Phillips, 1982), and regret (Bell, 1982; Clarke, Krase, & Statman, 1994). The sources of these irrationalities are often attributed to psychological factors fear, greed, and other emotional responses to price fluctuations and dramatic changes in an investor’s wealth. Although no clear alternative to the Efficient Markets Hypothesis has yet emerged, a growing number of economists, psychologists, and financial-industry professionals have begun to use the terms “behavioral economics” and “behavioral finance” to differentiate themselves from the standard orthodoxy. The fact that the current value of the Nasdaq Composite Index, a bellwether indicator of the technology sector, is 1646.34 (October 17, 2001) only 32.6% of its historical high of 5048.62 (March 10, 2000) reached less than two years ago lends credence to the critics of market rationality. Such critics argue that either the earlier run-up in the technology sector was driven by unbridled greed and optimism, or that the precipitous drop in value of such a significant portion of US economy must be due to irrational fears and pessimism.