anomalies in finance_what are they and what are they good for

8/4/2019 Anomalies in Finance_What Are They and What Are They Good For

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Anomalies in finance

What are they and what are they good for?

George M. Frankfurtera,

*, Elton G. McGounb,1

aLloyd F. Collete Professor Emeritus, Louisiana State University, Destin, FL, 32550, USAb Department of Management, Bucknell University, Lewisburg, PA 17837, USA

Abstract

In the natural sciences, anomalies contribute significantly to the development of new and ultimately

more successful theories. The role of anomalies in financial economics, however, has been quite

different. Although at the beginning, the word was used to show deviations from the Efficient MarketsHypothesis (EMH)/Capital Asset Pricing Model (CAPM) paradigm, lately, it has been applied to a new

literature that is also more accurately called Behavioral Finance (BF). This paper argues that this

misuse and misapplication of the word anomaly is not a simple coincidence. It is rather a sophisticated

and accordant effort to imply that although there are some unresolved deviations from the norm, the

reigning paradigm is irreplaceable, and its validity needs no empirical proof. In fact, an alternative

paradigm such as BF is not only insignificant but also unnecessary and even impossible. D 2001

Elsevier Science Inc. All rights reserved.

JEL classification: G00

Keywords: Anomaly; Methodology; Behavioral finance; Financial economics

1. Introduction

The word anomaly has gained both prominence and broadening use in that branch of

economics that is commonly referred to as financial, having become the standard label for a

flourishing and ever-expanding literature. Specifically, the word refers to a compendium of

1057-5219/01/$ see front matterD 2001 Elsevier Science Inc. All rights reserved.

PII: S 1 0 5 7 - 5 2 1 9 ( 0 1 ) 0 0 0 6 1 - 8

* Corresponding author. Tel.: +1-850-654-5250; fax: +1-850-654-5250.

E-mail addresses: [email protected] (G.M. Frankfurter), [email protected] (E.G. McGoun).1 Tel.: + 1-570-577-3732; fax: + 1-570-577-1338.

International Review of Financial Analysis

10 (2001) 407429


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studies that shows evidence contrary to the empirical validity of the Efficient Markets

Hypothesis (EMH, subsequently) of Fama (1965, 1970) and/or the Capital Asset PricingModel (CAPM, subsequently) of Black (1972), Lintner (1965), Sharpe (1964), and others. In

a recent paper, Fama (1998) implies that what is known today as Behavioral Finance (BF,

subsequently) is, in fact, the anomalies literature.

The objective of this paper is to show that this misuse and misapplication of the word

anomaly is not a simple coincidence. It is rather a sophisticated and accordant effort to

imply that although there are some unresolved deviations from the norm, the EMH/CAPM

combination is irreplaceable, and its validity needs no empirical proof. In fact, an alternative

paradigm such as BF is not only insignificant but also unnecessary and even impossible.

Fama (1998) does not stop short of arguing that only an alternative proven with much more

binding rigor can replace the EMH as a paradigm. If this claim is taken seriously, then,anomalies or not, the EMH is for all practical purposes immunized against any possibility of

rejection. This is so, because the existence of the EMH has itself never been proven with any

rigor, it having had to make do with circumstantial and indirect statistical evidence.

Famas (1998) paper is a landmark with respect to another consideration as well. This is

the first time that the advocates of the EMH/CAPM2 have found it necessary to defend so

rigorously their paradigm against another paradigm that shows more promise of coping

with the continuing onslaught of anomalous results, in essence, against what they call BF.

In earlier defenses of the EMH such as Ball (1996), anomalies were recognized but not

taken too seriously.3

The way we see it, the anomaly imbroglio has two dimensions:

1. Whether there is any significance to finances current misuse of the term other than

misunderstanding the underlying philosophy of science.

2. What the role of anomalies ought to be in the growth of scientific knowledge and in the

understanding of the financial world.

These two dimensions may not be totally independent of each other, which raises the

question of how researchers should deal with a situation that might, in fact, be more harmfulthan one would imagine at first look.

Consistent with the objective stated above, then, the following section deals with the

general thesis of what anomalies are in the philosophy of science, specifically in the

sociology of science approach of Thomas Kuhn, who introduced the term in its philosophical

sense. In the natural sciences, anomalies contribute significantly to the development of new

and ultimately more successful theories. Although the disinclination to accept new theories is

never trivial, eventually, usually with the help of better instruments of measurement,

resentment is overcome via the triumph of empirical evidence over ideology.

2 Fama argues that the two are inseparably linked together.3 In this paper, Ball argues that he was the first to find an anomaly in the finance paradigm and to use the

term as Kuhn (1970) used it. We will not consider the first claim here, but the second will be addressed in the

history of the use of the term in Section 3.

G.M. Frankfurter, E.G. McGoun / International Review of Financial Analysis 10 (2001) 407429408


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The role of anomalies in financial economics, however, has been quite different. In

Section 3, we document and evaluate the use of the word in the contemporary financeliterature. Although at the beginning, the word was used to show deviations from the EMH/

CAPM paradigm, lately, it has been applied to a new literature that is also more accurately

called BF. BF is work that questions some of the key behavioral assumptions of traditional

(also known as modern) finance. One consequence of this challenge is a rejection of the

EMH/CAPM. Although the methods of analysis of BF so far have remained the same as

those of modern finance, and its empirical domain is the same price/volume data, which

modern finance has mined for years, its findings jeopardize the ruling paradigm and perhaps

provide an opening toward a new way of thinking about financial phenomena.

Section 4 of the paper is about how observed phenomena become anomalies in financial

economics and what role they are playing in the process of discovery (search for truth). Wewill argue that for an empirical finding to become an unexplainable occurrence in finance;

that is, an anomaly, it has to go against the grain of the explicit and implicit axioms and

assumptions that together constitute the framework of the paradigm in which the phenomenon

is recognized. This fact has two important consequences:

1. It immunizes the broadly accepted paradigm from being replaced.

2. More importantly, it circumscribes the ontology (what is to be known) of the field

within rigid boundaries.

The second point constitutes an almost insurmountable roadblock in the development of

new and more comprehensive theories, because it sets out fairly specifically the phenomena

that are worth studying.

In Section 5, we offer our conclusions and express our hope that, somehow, the profession

is going to reconsider its ways of thinking and talking about itself.

2. What are anomalies?

The word anomaly has been associated with scientific and technological matters from

the very beginning of its use. Of its two general definitions, the first in The Oxford English

Dictionary (1989) is unevenness, inequality, of condition, motion, etc. (first used in this

sense in 1581: The excess whereby the Semidiameter of the Ringe or Cornice of the Head

dooth exceed the Cornice of the Coyle [of cannon] I call the Anomalye.). The second

general definition is irregularity, deviation from the common order, exceptional condition or

circumstance (first used in this sense in 1664: To admire Natures Anomaly . . . in the

number of Eyes, which she has given to several Animals), and more specifically in the

natural sciences, deviation from the natural order (first used in this sense in 1646: They

confound the generation of perfect animals with imperfect. . .

and erect anomalies, disturbingthe lawes of Nature.). All other definitions in the dictionary apply to specific disciplines, the

word being used in grammar (1612), astronomy (1669), music (1830), meteorology (1853),

and geography (1924).

G.M. Frankfurter, E.G. McGoun / International Review of Financial Analysis 10 (2001) 407429 409


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The use of the word anomaly in financial economics literally focuses on the second

definition; that is, an irregularity, a deviation from the common or natural order, or anexceptional condition. Of course, we must ask what it is that is regular, common,

natural, or unexceptional by which we identify an anomaly. In his famous work, The

Structure of Scientific Revolutions, Thomas Kuhn (1970) supplies us with one answer:

Discovery commences with the awareness of anomaly, i.e., with the recognition that nature

has somehow violated the paradigm-induced expectations that govern normal science. It then

continues with a more or less extended exploration of the area of anomaly. And it closes only

when the paradigm theory has been adjusted so that the anomalous has become the expected

(Kuhn, 1970, p. 52).

Therefore, an anomaly exists in opposition to a paradigm, which Kuhn elsewhere inhis essay introduces thus:

In this essay, normal science means research firmly based upon one or more past scientific

achievements, achievements that some particular scientific community acknowledges for a

time as supplying the foundation for its further practice . . .. Achievements that share these

two characteristics4 I shall henceforth refer to as paradigms, a term that relates closely to

normal science (Kuhn, 1970, p. 10).

A few observations are in order here. First, Kuhn does not introduce the term anomaly

until p. 52 of his essay, and when he does, he does not enclose it within single quotations as

he does with the terms normal science and paradigm when he introduces them. Thisimplies that he has simply chosen what he feels is the appropriate word to say what he means

to say and does not intend to give it any new or special meaning. As we have seen from The

Oxford English Dictionary, his use of anomaly is perfectly consistent with the meanings it

has had for over 400 years, and before using the word anomaly, he refers to fundamental

novelties of fact, new and unsuspected phenomena, and surprises, which are

apparently synonymous terms and phrases.

Also interesting is Kuhns distinction between anomalies and puzzles, another word

that is not introduced in single quotation marks.

Puzzles are, in the entirely standard meaning here employed, that special category ofproblems that can serve to test ingenuity or skill in solution . . .. It is no criterion of goodness

in a puzzle that its outcome be intrinsically interesting or important . . .. Though intrinsic

value is no criterion for a puzzle, the assured existence of a solution is . . .. A paradigm can,

for that matter, even insulate the community from those socially important problems that are

not reducible to the puzzle form, because they cannot be stated in terms of the conceptual and

instrumental tools the paradigm supplies (Kuhn, 1970, p. 36).

4 According to Kuhn, the two characteristics are:

[1] Their achievement was sufficiently unprecedented to attract an enduring group of adherents away from

competing modes of scientific activity.

[2] Simultaneously, it was sufficiently open-ended to leave all sorts of problems for the redefined group of

practitioners to resolve (Kuhn, 1970, p. 10).



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It is during puzzle solving that anomalies appear, thereby potentially precipitating a

crisis, although it is interesting that in making this important point, Kuhn does not use theword anomaly.

Because it demands large-scale paradigm destruction and major shifts in the problems and

techniques of normal science, the emergence of new theories is generally preceded by a

period of pronounced professional insecurity. As one might expect, that insecurity is

generated by the persistent failure of the puzzles of normal science to come out as they should

(Kuhn, 1970, p. 67).

In another article written at the same time as The Structure of Scientific Revolutions, Kuhn

(1977a) makes a point concerning anomalies that is missing from the more famous work.

Whatever the level of genius available to observe them, anomalies do not emerge from thenormal course of scientific research until both instruments and concepts have developed to

make their emergence likely and to make the anomaly which results recognizable as a

violation of expectations. [Continuing in a footnote] . . . the conditions which make the

emergence of anomaly likely and those which make anomaly recognizable are to a very great

extent the same (Kuhn, 1977a, p. 173).

This makes it sound as if anomalies are not just contrary results that appear in the course of

normal Popperian attempts at empirical falsification of a theory, hypothesis, or model, during

which testing disconfirming evidence may be unwelcome but hardly unexpected. Rather, they

are indeed fundamental novelties of fact, new and unsuspected phenomena, andsurprises that pop up later when new data permit new tests. And thereafter they persist.

Anomalies, by definition, exist only with respect to firmly established expectations.

Experiments can create a crisis by consistently going wrong only for a group that has

previously experienced everythings seeming to go right (Kuhn, 1977b, p. 221).

The usual response to anomalies is, not unsurprisingly, denial.

Let us then assume that crises are a necessary precondition for the emergence of novel

theories and ask next how scientists respond to their existence. Part of the answer, as obvious

as it is important, can be discovered by noting first what scientists never do when confronted

by even severe and prolonged anomalies. Though they may begin to lose faith and then toconsider alternatives, they do not renounce the paradigm that has led them into crisis. They do

not, that is, treat anomalies as counter-instances, though in the vocabulary of philosophy of

science that is what they are (Kuhn, 1970, p. 77).

Not all anomalies, however, precipitate crises that lead to significant changes in the

paradigm. However, anomalies do demand that some sort of action eventually be taken to

address them, and they often point out the most fruitful directions for future research

(Kuhn, 1977b).

During the course of his career, every natural scientist again and again notices and passes by

qualitative and quantitative anomalies that just conceivably might, if pursued, have resulted in

fundamental discovery . . .. But anomalies are not always dismissed, and of course they

should not be . . .. [The] discrepancy will probably vanish through an adjustment of theory or

apparatus; as we have seen, few anomalies resist persistent effort for very long. But it may



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resist, and, if it does, we may have the beginning of a crisis or abnormal situation (Kuhn,

1977b, p. 202).

The quotations from Kuhn we have selected for this paper express our best understanding

of what he means by the term anomaly. We must admit, however, that Kuhn is not at all

clear on when an experiment has uncovered an anomaly and when it has simply not turned

out as a scientist thought it should turn out. This is a very important question that he never

explicitly resolves. Are all experimental results that are contrary to theoretical expectations

anomalies, or are anomalies something special, which begin to turn up when previously

successful theories begin to be tested with better instruments and/or better data?

For the most part, Kuhn reserves the word anomaly for something special, but in the

preceding quotation and in the following quotation, he does seem to say that all discrepancies

in experimental results are anomalies.

How, then, to return to the initial question, do scientists respond to the awareness of an

anomaly in the fit between theory and nature? What has just been said indicates that even a

discrepancy unaccountably larger than that experienced in other applications of the theory

need not draw any very profound response. There are always some discrepancies. Even the

most stubborn ones usually respond at last to normal practices. Very often scientists are

willing to wait, particularly if there are many problems available in other parts of the field

(Kuhn, 1970, p. 81).

Assuming that not all discrepancies are really anomalies, it can never be immediately clear

which unexpected results or discrepancies are, in fact, anomalies and which are not. Lakatos

(1970) and Lightman and Gingerich (1991) even argue that at least certain anomalies are not

recognized as such until they have been explained by a new theory or within a new

paradigm.5 This is certainly consistent with Kuhn, whose use of the word largely implies that

anomalies must in some way be detrimental to the current paradigm or else they would

simply be unsolved puzzles within it.

Recall that according to Kuhn, the first response of scientists is to deny anomalies and not

treat them as counter-instances, though in the vocabulary of philosophy of science that is

what they are. What this means is that calling a fundamental novelty of fact, a new and

unsuspected phenomenon, or a surprise an anomaly, with full knowledge of what theterm means in the philosophy of science, is in effect an admission that the current paradigm at

least needs serious attention if not to be replaced entirely with another.

As we have already noted, Kuhn is not perfectly clear on how to identify an anomaly,

so we cannot blame anyone for not knowing exactly how and when to use the term.

Lakatos (1970) even criticizes the extreme point of view of those who he refers to as

naive falsificationists:

They do not believe that there is a relevant difference between anomalies and crucial

counterevidence. For them, anomaly is a dishonest euphemism for counterevidence (Lakatos

1970, p. 120).

5 The lethal nature of some others can be recognized immediately without a new paradigm.



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What this all seems to mean is that experiments can go wrong (yield unexpected results in

light of the theory being tested) for three reasons: (1) there is some sort of discrepancy,which can be resolved within the current theory/paradigm with better experimental proce-

dures; (2) there is an anomaly or counter-instance, which will at least require a

significant reworking of the theory/paradigm; (3) there is a sufficiently serious anomaly

or crucial counter-instance, which will require abandonment and replacement of the

theory/paradigm.

One last aspect of Kuhn that finance has frequently drawn upon to sustain the EMH/

CAPM is his view concerning this abandonment and replacement of a paradigm.

Once a first paradigm through which to view nature has been found, there is no such thing as

research in the absence of any paradigm. To reject one paradigm without simultaneouslysubstituting another is to reject science itself (Kuhn, 1970, p. 79).

We must keep in mind, however, that, here, Kuhn is speaking descriptively and not

prescriptively. The reason we have to replace a theory or paradigm with another is not

because science necessarily progresses with a succession of better and better theories or

paradigms, but because it is not possible to do science without one.

. . . once it has achieved the status of paradigm, a scientific theory is declared invalid only

if an alternate candidate is available to take its place. No process yet disclosed by the

historical study of scientific development at all resembles the methodological stereotype of

falsification by direct comparison with nature. . .

. The decision to reject one paradigm isalways simultaneously the decision to accept another, and the judgement leading to that

decision involves the comparison of both paradigms with nature and with each other

(Kuhn, 1970, p. 77).

We must also keep in mind that according to Lakatos (1970), it is naive falsificationists

who assert that:

. . . in spite of hundreds of known anomalies we do not regard [a specific theory] as falsified

(that is, eliminated) until we have a better one (Lakatos, 1970, p. 121).

This perfectly, and very succinctly, captures Famas (1998) argument that until BF

proves itself to be better than the EMH/CAPM, it does not matter how many anomaliesare discovered.

3. What are anomalies in finance?

3.1. History

The efficient markets literature originated in the 1950s, developed in the 1960s, and was

fully articulated as the EMH in 1970 in a famous article by Eugene Fama (1970).6

During the

6 Frankfurter and McGoun (1999) briefly survey this history with an emphasis on the use of the word

efficiency.



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1970s, the EMH was tested, using the CAPM to specify what returns should have been if the

market were efficient, necessarily making such tests joint tests of both theories. A number of

systematic deviations from theoretical expectations were discovered; that is, there appeared to be predictable opportunities for earning abnormal returns using rather simple trading

strategies. This literature was the subject of a special issue in 1978 of the Journal of

Financial Economics, in which these deviations were labeled anomalies. This marked the

first significant use of the word in finance.

Table 1 includes the results of a search for variations of the word anomaly in titles and

abstracts in the Economic Literature Index 19691999 of the American Economic Asso-

ciation. According to this database, its first use in finance was in 1975 in an article by Gentry

(1975) Capital Market Line Theory, Insurance Company Portfolio Performance, and

Empirical Anomalies in the Quarterly Review of Economics and Business.7

Gentry,however, does not use the term in a Kuhnian sense in reference to findings which differ

Table 1

Occurrences of words and phrases in titles and abstracts from the Economic Literature Index 19691999 of the

American Economic Association

January Weekend Small firm Total effects Anomalies

1998 5 0 3 8 15

1997 6 4 3 13 9

1996 8 4 5 17 16

1995 6 2 2 10 13

1994 7 4 2 13 12

1993 9 3 1 13 12

1992 7 5 5 17 12

1991 7 3 3 13 6

1990 6 3 3 12 61989 7 5 1 13 0

1988 2 8 2 12 4

1987 5 2 4 11 2

1986 2 1 0 3 6

1985 1 2 2 5 0

1984 0 3 1 4 1

1983 0 0 2 2 1

1982 0 1 0 1 0

1981 0 0 1 1 0

1980 0 1 0 1 0

1979 0 0 0 0 01978 0 0 0 0 2

1977 0 0 0 0 0

1976 0 0 0 0 0

1975 0 0 0 0 1

1974 0 0 0 0 0

1973 0 0 0 0 1

7 The first use in 1973 that the literature search produced was in article published in Italian (Lotti, 1973).



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from those predicted by finance theory. Rather, he uses it to refer to differences between

market data and the assumptions upon which finance theory is based.

8

Although the test results were positive, several anomalies emerged between the actual

attributes of the data and the assumed attributes derived from market line theory (Gentry, 1975,

p. 14).

Balls (1978) article in that special issue of the Journal of Financial Economics does

indeed appear to have been the first to make substantial use of the word anomaly in finance

in a Kuhnian sense.9 In fact, Ball makes an explicit reference to Kuhn:

It seems that the researchers position qua scientist is quite clear. There is nothing that can be

done to directly verify the claims, because the perfect model of the determination of

securities expected returns in equilibrium, of course, is not available. There is nothing thatnecessarily should be done because, as argued by Kuhn (1969 sic10), no area of normal

science can justify chasing all anomaly at the expense of more fruitful research. The one

proviso is that, if the anomaly is judged to be sufficiently large to hinder normal research,

then it must be resolved (Ball, 1978, p. 117).

This is an accurate literal interpretation of Kuhn, but a quite inaccurate one of his spirit. It is

worth repeating here a short quotation from Kuhn that we discussed in the preceding section.

Anomalies, by definition, exist only with respect to firmly established expectations.

Experiments can create a crisis by consistently going wrong only for a group that has

previously experienced everythings seeming to go right (Kuhn, 1977b, p. 221).

Bear in mind that the CAPM appeared in 1964 and the EMH in 1970, and that joint tests of

the two were first conducted in earnest in the 1970s. At the time that Balls article was

published, there was no body of empirical literature supporting everythings seeming to go

right. Ball and others may have indeed had firmly established expectations in 1978

concerning the CAPM and EMH, but they could only have been ideological beliefs. By no

means were they scientific results.

In his introduction to the special issue, the editor, Michael Jensen (1978) views the matter

slightly differently than Ball, at least early in his article.

Yet, in a manner remarkable similar to that described by Thomas Kuhn in his book, The

Structure of Scientific Revolutions, we seem to be entering a stage where widely scattered and

as yet incohesive evidence is arising which seems to be inconsistent with the theory. As better

data become available (e.g. daily stock price data) and as our econometric sophistication

increases, we are beginning to find inconsistencies that our cruder data and techniques missed

in the past. It is evidence which we will not be able to ignore.

9 We know of at least one preceding article (Boness & Frankfurter, 1977), however, which did make use of the

word anomaly in a Kuhnian sense within the article without referring to Kuhn explicitly.10 Most scholars refer to the second expanded edition of Kuhns The Structure of Scientific Revolutions

published in 1970. The first edition was published in 1962. Balls date of 1969 is incorrect.

8 In Section 4, we assert that such differences are the source of anomalies, but they are not the anoma-

lies themselves.



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The purpose of this special issue of the Journal of Financial Economics is to bring together a

number of these scattered pieces of anomalous evidence regarding Market Efficiency. As Ball

(1978) points out in his survey article: taken individually many scattered pieces of evidence

on the reaction of stock prices to earnings announcements which are inconsistent with the

theory dont amount to much. Yet viewed as a whole, these pieces of evidence begin to stack

up in a manner which make a much stronger case for the necessity to carefully review both

our acceptance of the efficient market theory and our methodological procedures.

It is my hope that bringing the studies contained in this volume together in one place will help

to highlight and hasten the progress of what I believe is a coming mini-revolution in the field.

Focusing the attention of scholars throughout the world on these disturbing pieces of

evidence will, I hope, result in the resolution of the questions they raise . . . The eventual

resolution of these anomalies will result in more precise and more general theories of marketefficiency and equilibrium models of the determination of asset prices under uncertainty

(Jensen, 1978, p. 95).

Like Ball, Jensen implies that there is substantial body of past findings in support of the

EMH that may not really have been there. Unlike Ball, however, he describes the current

anomalies as evidence that we will not be able to ignore and as disturbing harbingers

of a coming mini-revolution. However, this may be more a matter of marketing this issue

of the journal than of his own convictions. At the conclusion of his article, he describes

something that hardly qualifies as a Kuhnian revolution, even a mini one.

Unlike much of the inefficiency literature of the past, each and every one of these studies is

a carefully done scientific piece. Each of the authors displays in varying degrees a commonly

held allegiance to the Efficient Market Hypothesis witness the general reluctance to reject the

notion of market efficiency.

Viewed as a whole, however, the studies provide a powerful stimulus and serve to highlight

the fact that there are inadequacies in our current state of knowledge. My reaction to this is

one of excitement and enthusiasm. I have little doubt that in the next several years we will

document further anomalies and begin to sort out and understand their causes. The result will

not be an abandonment of the efficiency concept, nor of asset pricing models. Five years

from now, however, we will as a profession have a much better understanding of theseconcepts than we now possess, and we will have a much more fundamental understanding of

the world around us (Jensen, 1978, p. 100).

Note the marked ideological biases in this passage. According to Jensen, the previous

studies challenging market efficiency were not carefully done scientific pieces, but those in

this volume, done by those who have an allegiance to the EMH and a general reluctance

to reject it, are. On the one hand, this may mean that we ought to trust the inefficiency

findings of EMH supporters more than those of EMH critics, who obviously have their own

ideological axes to grind. On the other hand, however, it may be implying that only EMH

supporters are capable of doing top-notch scientific work, and only inferior researchers wouldnot have a prior belief in the EMH.

In the final paragraph, what Jensen predicts is definitely not a Kuhnian revolution of any

sort; that is, that the result of research into these anomalies will be a greater understanding



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of efficiency and asset pricing models. In other words, at the end of five years of

research, markets will still be able to be characterized as efficient in some way or other,and we will still have mathematical asset pricing models to describe their behavior.

Thus, this issue of the journal is not really about anomalies at all, but about what Kuhn

called puzzles.

Notice from Table 1 that the word anomaly virtually disappeared from finance again for

several years after this special issue.11 For a time, the more neutral word effect was much

more common. The table lists the appearance of three of the more prominent effectsthe

January Effect, the Weekend Effect, and the Small Firm Effect. Anomaly was

more or less revived in 1986 with an article published by Kleidon (1986) in the Journal of

Business, an article which was originally presented at the 1985 Conference on Behavioral

Foundations of Economic Theory at the University of Chicago and included in a 1987compilation of the proceedings of this conference (Hogarth & Reder, 1987).

Kleidon brings up Kuhn at the very beginning of his article, the main purpose of which is

to assess the variance bounds literature. First, he quotes Kuhn concerning the important issue

we addressed in Section 2; that is, when an observed anomaly is a serious counter-instance

that precipitates a crisis that leads to a paradigmatic revolution and when it is a more minor

issue. Kleidons comment following his quotation from Kuhn12 makes it clear that he

considers the anomalies addressed in the variance bounds literature to be unimportant.

Moreover, these are not even real anomalies, but seeming anomalies.

. . .

it is likely that we will always be contending with anomalies recently generated by

empirical research. Many of these will be dispelled by more refined observation, but, as in the

past, some will persist and cause revisions of relevant theory. At any given time, researchers

are forced to decide whether a seeming anomaly is of the formertransitorykind or

presents an opportunity for viable reconstruction of theory. In financial economics, such a

seeming anomaly has been generated by some recent research that challenges an underlying

model, namely, that stock prices can be regarded as the present value of rationally forecasted

future cash flows (Kleidon, 1987, p. 286).

11

The 1983 reference was in the Journal of Public Economics (Hamilton, 1983) and in 1984 in the AccountingReview (Foster, Olsen, & Shevlin, 1984). Neither of these is a finance journal, although the latter article concerns a

finance topic. The literature search did not turn up all articles explicitly concerning anomalies in finance, however,

since we know of at least two others published during this period (Keim, 1983; Reinganum, 1981).12 This quotation is from p. 81 of The Structure of Scientific Revolutions, a portion of which we quoted in

Section 2. Later in the paper, Kleidon paraphrases the question in his own words to introduce his own discussion

of the subject with regard to finance and economics,

If it is true that the profession will always be faced with some anomalous differences between theory and

data, when does an anomaly cease being regarded as a challenging puzzle to be solved within the current

framework, to become regarded as evidence that some fundamental change in worldview is desirable? The

issue revolves around the benchmark that is used to measure successful reconciliation of data with theorysince what is anomalous from one viewpoint may be self-evident from another. This section examines and

suggests, first, that some kinds of anomalies are more likely to lead to serious changes in the behavioral

foundations of economics than others and, second, that not all subfields or models in economics are

equally susceptible to changes of this nature (Kleidon, 1987, p. 304).



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In fact, what Kleidon is calling an anomaly would probably not be an anomaly at all by

Kuhns definition. Seeming anomaly may be a technically accurate term for what are reallydiscrepancies, but still a misleading one.

What is especially interesting and significant in Kleidons article is that after having

disparaged the evidence suggesting irrational behavior in stock market pricing, he spends

considerable time addressing whether the behavioral foundations of finance and economics

ought to be changed or not. He turns once again to Kuhn to structure his argument.

Kuhn (1970, p. 84) suggests that, historically, there have been three responses to significant

anomalies (which in his terminology produce a crisis for the affected discipline). First, what

initially appeared to be anomalous may be subsequently explained within the original

disciplinary framework. Second, the problem may be regarded as insoluble with the currentstate of knowledge and left for future generations. Third, and most relevant here, the

disciplinary foundations may change so that, within the new framework, the anomaly is

explained (Kleidon, 1987, p. 306).

It is worth emphasizing Kleidons parenthetical material. Kuhn would probably argue that

all anomalies are significant by definition, and that if they can be explained within the

original disciplinary framework, they would never be anomalies. What happens is that

anomalies are initially mistaken for discrepancies and not vice versa.

Following this, Kleidon (1987) specifies his criteria for a new theory. It is one that

explains the original anomaly;

does not destroy too much of what was known under the previous theory;

provides promise for future work; and

meets the same standards of explanatory rigor to which the old theory is being subjected

(i.e., it does not have equally serious anomalies of its own).

With respect to these criteria, he argues that the variance bounds literature has, first,

failed to firmly establish that there is an anomaly and then, second, failed to meet the

standards of the economic profession, which has come to expect certain standards of

compatibility with assumptions found successful in other applications (such as rational

expectations), specificity of modeling and prediction, and past and future empirical success

(Kleidon, 1987, p. 310).

Finally, it is worth quoting substantially from Kleidons conclusion, as it is has

remained finances typical response to what critics regard as empirical refutation of its

theories and as it includes the use of appropriate descriptive language to disparage the

behavioral alternative.

The analysis in this paper suggests that the case for radical change of behavioral assumptions

underlying economic models based on the results of variance bounds tests may be easily

overstated. There are serious questions concerning whether the phenomenon of excess

volatility exists in the first place and, if it did, whether abandonment of assumptions of

rational expectations in favor of assumptions of mass psychology and fads as primary

determinants of price changes is the best avenue for current research.



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. . . It is still too early to tell which, if any, of these puzzles will prove incorrigible within the

current framework of financial economics and consequently call the disciplinary foundations

into serious question. What is clear at this stage, however, is that none of them is sufficiently

well formulated to allow it to take the role of a critical experiment discussed earlier. In short,

whether or not their existence eventually leads to a significantly different disciplinary

framework, they do not provide a blueprint for such change (Kleidon, 1987, p. 313).

4. Discussion

This sections history of finances use of the term anomalies in the sense that Kuhn

introduced it into the sociology of science has necessarily been brief. However, it should besufficient to show how it has come to have its current connotations in the discipline. The

special issue of the Journal of Financial Economics in 1978, referred to above, appears to

have firmly associated the word very specifically with evidence contradictory to the EMH

and the CAPM. In addition, the Conference on Behavioral Foundations of Economic Theory

at the University of Chicago in 1985 appears then to have firmly associated the word

specifically with BF as the alternative to them. So in 1998, Fama, who was not uncoinci-

dentally a session chair at the 1985 conference, publishes an article in the Journal of

Financial Economics, again not uncoincidentally, in which BF is the anomalies literature.

The extended, albeit still quite abbreviated discussion of anomalies thus far, quotingliberally from Kuhn (1970), does provide us with the essential background for evaluating the

current use of the term anomaly in finance. Kuhns is likely to be one of the two

methodological works that finance professors have read, or at least heard of,13 and as we have

seen, their use of the term can usually be directly or indirectly attributable to him.

Additionally, as Kuhn was among the first to try to elucidate how the process of science

actually works, as opposed to how it is supposed to work, he provides a basis for

evaluating whether what is happening in finance is normal or whether the process has been

perverted in some way.

Kuhn does not represent himself as having written the definitive description of how a

scientific revolution is effected.

In addition, the view of science to be developed here suggests the potential fruitfulness of a

number of new sorts of research, both historical and sociological. For example, the manner in

which anomalies, or violations of expectation, attract the increasing attention of a scientific

community needs detailed study, as does the emergence of the crises that may be induced by

repeated failure to make an anomaly conform (Kuhn, 1970, p. ix).14

Thus, we certainly cannot call upon Kuhn as the definitive authority to assert that the

EMH/CAPM has lived with its anomalies for far too long without having been abandoned,

which it may certainly seem has occurred.13 The other is Friedman (1953).14 Note here that by not preceding the word violations with the qualifying adjective repeated, Kuhn once

again comes close to confounding the words anomaly and discrepancy.



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As we have stated, most of the so-called anomalies concerning the EMH/CAPM have

been known to finance from the very beginning of their testing, and in all fairness, actionshave been taken to adjust the EMH/CAPM to address disconfirming evidence. So far,

however, most articles concerning the issue, of which Fama (1998) is certainly an exemplar,

look more like displays of mathematical virtuosity, patched up patterns of trial-and-error,15 or

deliberate attempts at immunization than like the serious attention to fundamentals that is

called for.

For the most part, finance has belied Kuhns contention that: No crisis is, however, so

hard to suppress as one that derives from a quantitative anomaly that has resisted all the usual

efforts at reconciliation (Kuhn, 1970, p. 209). Perhaps this is a reflection of the fact that

however hard the social sciences such as economics and finance attempt to emulate the

natural sciences, their inability to subject most phenomena to controlled experimentationnecessarily introduces a significant qualitative component into any quantitative work.

Finance, for example, can often make no prediction stronger than that the price of something

will rise under certain circumstances, as opposed to remaining unchanged or fallinga

prediction that is, in fact, qualitative, although in testing the prediction, price will be

quantitatively measured. As Kuhn goes on to note:

By their very nature, qualitative anomalies usually suggest ad hoc modifications of theory

that will disguise them, and once these modifications have been suggested there is little way

of telling whether they are good enough. An established quantitative anomaly, in contrast,

usually suggests nothing except trouble (Kuhn, 1970, p. 209).

There are, however, aspects of finances use of the term anomaly that are clearly

perverse. One is its limited use. Anomaly is a generic term that applies to any

fundamental novelty of fact, new and unsuspected phenomenon, or surprise with

regard to any theory, hypothesis, or model. Yet, the term is used exclusively in finance with

reference to the EMH/CAPM. It is therefore not surprising that anomaly has become

synonymous with BF, which is at present the only quasiofficially acknowledged alternative

to the EMH/CAPM. Thus, BF is not just an attempt to explain the anomalies which testing

the EMH/CAPM has generated, it has, in some sense, become an anomaly, in the literal sense

of the word itself. For BF to be called the anomalies literature is not the same as to call it aliterature that among other things is concerned with a certain set of anomalies concerning a

specific piece of the modern finance paradigm.

A more important perverse aspect of finances use of the term anomaly lies in the

implication inherent in the word that a paradigmatic revolution, or at least substantial revision

of the current paradigm, is necessary. One cannot, therefore, call a set of observations

anomalies for decades without necessarily recognizing the failure of the current paradigm,

as is, to explain them, not only for the time being, but permanently. So to attempt so

rigorously to salvage the EMH/CAPM pretty much intact in the face of an anomaly

literature is either an admittedly meaningless task or a consequence of ignorance of theunderlying philosophy.

15 This description is used by Lakatos (1970).



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Even if mainstream finance does not accept BF as a better alternative, it ought to be

sincerely searching for one, even if it is only a modification of the current one, and this nolonger seems to be happening. As finance researchers are probably not knowingly wasting

their time engaged in a futile activity, it is more likely that they are methodologically (not

methodically) unaware of what is going on. But then just why is it that they use this particular

word anomaly so inappropriately?

One reason is perhaps to make it appear as if finance has given some thought to its

methodology, and not simply to its methods. However, the real reason may lie in the non-

Kuhnian senses of the word. Recall that an anomaly is an irregularity, deviation from the

common order, exceptional condition or circumstance or a deviation from the natural order.

If one looks at what is regular, common, natural, or unexceptional not as the current

scientific paradigm, but as something that is a part of what might be called the natural order ofthings, then anomaly becomes a pejorative term applied to something not just inconsistent

with a paradigm, but with a deeper underlying ideology. It follows that by referring to what the

EMH/CAPM proponents find inconvenient as anomalies is a means of marginalizing or

trivializing them; and calling BF the anomaly literature is a means of discrediting it.

Lakatos (1970) supplies us with another explanation for the attention, which anomalies are

receiving in finance in the form of an anomaly literature.

Which problems scientists working in powerful research programmes rationally choose is

determined by the positive heuristic of the programme rather than by the psychologicallyworrying (or technologically urgent) anomalies. The anomalies are listed but shoved aside in

the hope that they will turn, in due course, into corroborations of the programme. Only those

scientists have to rivet their attention on anomalies who are either engaged in trial-and-error

exercises or who work in a degenerating phase of a research programme when the positive

heuristic has ran out of steam (Lakatos, 1970, p. 137).

In other words, the EMH/CAPM research is not moving forward, having no important or

even interesting puzzles it looks as if it can solve. Instead, to keep itself occupied, it has

turned around and taken on BF, which is nipping at its heels.

This concludes our discussion of what the word anomaly means in a general sense andin Kuhns sociology of science sense, our review of the history of its use in finance, and our

speculation about what its use may mean in finance. These issues all make up the first

dimension of the anomaly imbroglio, as we described it in the Introduction. Now, we turn to

the second dimension concerning what it is that finance considers being anomalies and what

their roles ought to be in the growth of scientific knowledge and understanding of the

financial world.

5. Where do anomalies in finance come from?

What makes an empirical finding or disputation an anomaly? There must be some sort of

powerful paradigm, in a Kuhnian sense or otherwise, which defines what is considered an

irregularity, deviation from the common order, exceptional condition or circumstance. That



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is, there must be a strong structure, ideological, religious, or other, that defines regularity,

common order, normal conditions, or expected circumstance. In a meta-science such aseconomics, financial, or otherwise, this structure is an assemblage of axioms. De facto,

axioms are just a set of assumptions that originally had a degree of verity much weaker

than true axioms but which somehow became deeply entrenched in the field. Because of

this entrenchment, no one questions the verisimilitude of these conjectures any longer.

Thus, the word axiom is commonly defined and used as a universal, or self-evident truth,

a maxim.

Axioms then become the foundations of theories and thus circumvent any need to prove

whether the axioms themselves are veritable. In reality, many of the axioms upon which an

economic doctrine is built are nothing more than hypotheses, deriving from some basic

understanding of the state of the world as perceived by the creators and propagators of a particular paradigm or as adopted by them as a matter of convenience for further theory

building. In essence, most of the axioms that we take for granted are self-serving. Albert Jay

Nocks observation, It is an economic axiom as old as the hills that goods and services can

be paid for only with goods and services, is an example of the efforts of many economists to

portray human behavior as selfish and motivated only by rewards directly translatable into

monetary units, or barter.

The commonly accepted rationale of economic behavior in financial economics is

grounded on the paradigm of expected utility of wealth developed by Von Neuman and

Morgenstern (1967) (VM, subsequently) on the foundations of the theory toward risk takingin games of chance by the Bernoullis.16 The VM paradigm is called axiomatic, because the

risk-return space mapping of investment behavior of economic agents is the consequence of

six axioms. Although this set of axioms had been reproduced in countless places, in the

interest of convenience we briefly summarize them as they appear in Frankfurter and Phillips

(1995, p. 7).

6. The Von Neumann and Morgenstern axioms

Axiom 1: Comparability

For any pair of investment opportunities, A and B, one of the following must be true: the

investor prefers A to B, B to A, or is indifferent between A and B.

Axiom 2: Transitivity

If A is preferred to B, and B is preferred to C, than A is preferred to C.

Axiom 3: Continuity

If investment outcome A is preferred to B, and B to C, then there is some probability Psuch

that the investor would be indifferent between the certain event B and the uncertain event

{PA + (1

P)

C}.

16 See Bernoulli (1954) and the summary in Maistrov (1974).



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Axiom 4: Independence

If an investor is indifferent between the certain outcomes A and B, and C is any othercertain outcome, then he is also indifferent between the uncertain events {PA + (1P)C}

and {PB + (1P)C}.

Axiom 5: Interchangeability

If an investor is indifferent between two uncorrelated risky income streams, then the

securities that produce them are interchangeable in any investment strategysimple

or complex.

Axiom 6: Risk Aversion

If securities A and B offer the same positive rate of return, R =X, with probabilities Pa and

Pb, respectively, and otherwise R = 0 with probabilities (1

Pa) and (1

Pb), respectively,then A is preferred to B if Pa>Pb. Moreover, ones relative preference for A in this case is a

(possibly complex) monotonic function of the relative certainty coefficient Pa/Pb (Von

Neuman & Morgenstern, 1967, p. 7).

Until the emergence of BF, and of the prospect theory of Kahnman and Tversky (1979)

upon which BF is built, no one in finance questioned, seriously, the veracity of the VM

axioms. In fact, the tome of modern finance, in excess of 60,000 scientific papers both

published and presented before learned societies, is exclusively based on the VM axioms.17

Yet, all six of them are highly questionable as a mode of behavior, their implication being thatinvestors are totally keen, penetrating and rational in calculating the numbers that are required

for investment decision making. This, of course, is a mere fiction that flies in the face of a

multitude of psychological studies showing human behavior to be otherwise. The emergence

of what is termed today BF is a direct consequence of the realization of the sophistry of the

VM axioms. Why then is there such strong adherence to these axioms18 by the practitioners

of the orthodox financial economics? The answer is very simple: the axioms are the sine qua

non for comprehensive model building.

What is more disturbing than the explicitly stated axioms that serve as the foundation of

accepted dogma (which, after all, are open to criticism if one can find a publication outlet

supportive of such rebuke) are those axioms that are never explicitly stated. These comprise

that set of universal truths that forms the foundations of research in which the growth of

scientific knowledge of a discipline is grounded. Of the two sets of axioms, which we might

17 These axioms may be true or false as applied to a particular investor. However, to the extent that investors

do calculate and are willing to acknowledge the existence of risk, the VM axioms are restrictive only with regard

to the continuity assumption, which is inconsistent with Roys (1952) safety-first argument. It is hard to see

how one can have Stochastic Dominance without satisfying (Axioms 1, 2, 4, and 5). Axioms 6 is explicitly

assumed by Markowitz (1952), and his portfolio expectation and variance operators follow from Axioms 3.However, this, of course, is the normative model. Sharpes (1963) derivation is based on the Markowitz results,

plus equilibrium restrictions that, except for the borrowing and lending have no other purpose but to make the

homogeneous expectations assumption in Sharpe (1964) plausible.18 Bear in mind that as we have stated, these are, in fact, no more than highly questionable assumptions.



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call the seen and not seen, the more perilous is the latter. This is because refutation of

the dogma is contingent on the validity of the unseen axioms. Since they are not seen, theyare cloaked in taboo and thus shielded from questioning.

Let us cite just five among the most influential of these unwritten truths. Although there are

quite possibly more than these five, we think that these are the most harmful and the least

conducive to the development of a new methodology of financial economics.

(I) The term financial economics by and of itself. On the surface, this term seems to be a

rather innocuous label for theoretical work in the field of finance, which is performed by

those who are regularly called financial economists (although we have never heard of a

practitioner being labeled a financial economist, instead of a financial analyst). Inherent

in the label, however, is the notion that finance and economics are one and the same; or rather,

that the only underlying logic of finance and the behavior of individuals, firms, nonprofitorganizations, and other micro units, either alone or together, is described and prescribed by

the same logic or paradigm upon which economic theory rests. We are not clear on when the

term was first used in a professional paper, as our efforts to pinpoint its debut in the literature

have so far been fruitless. Regardless, the term has enjoyed broad use since the first

appearance of the journal that bears that name.

One must be hopelessly naive not to suspect that the title of the journal, the term, and

the school of thought that promote the underlying notion are closely tied. Yet, anyone

who is even superficially familiar with the finance process in organizations and the

financial behavior of individuals knows that decisions are often made on the basis ofconsiderations totally contrary to economic logic that Miller (1977) in his presidential

address to the American Finance Association called heuristic. More important, and

highly questionable, is the notion that from the analysis of massive electronic data one

can infer the motivations of individuals and firmsa notion that is anchored in the use of

the term.

(II) The axiom that a complicated mathematical problem can be disaggregated into its

simple parts, which, in turn, can be solved individually and separately and then

reaggregated to provide a solution to the complex problem. In other words, that the

sum of the parts is equal to the whole. This view brings to mind the analogy that by putting two semiliterate persons together, one could obtain one literate person. Who would

accept this idea? Why then do we behave as if this is the natural order of things in our

theoretical developments?

(III) The axiom that cultural processes such as rituals, customs, and habits can be modeled

mathematically. Ernest Gellners (1993) review of In Search of a Better World: Lectures and

Essays of Thirty Years by Karl R. Popper observes:

The whole point about what anthropologists call culture is that it is not optional as

between various cultures. An activity inherently polluting in one society is neutral in

another; an act that constitutes a solemn statusconferring ritual in one society means

nothing in another; and so on. Anthropologists are concerned with describing and

explaining the manner in which diverse societies construct worlds that are felt, internally, to

be binding and obligatory but are, from the vantage point of intercultural space, nothing of

the kind (Gellner, 1993, p. 37).



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One paragraph later, Gellner argues that Popper and Wittgenstein reach a curious similarity:

. . .

cultures, though variable and optional, came to constitute the only possible, but adequate,validation of our practices. This lumping together of utterly optional rituals . . . with

interculturally cogent procedures (mathematics) is absurd and indefensible (Gellner, 1993,

p. 38).

If one is to accept this argument as an axiom (and we are not saying that one necessarily

should, although its logic in describing human behavior is quite convincing), then much of

the agency theory and postagency theory literature, especially that of the market-for-

corporate-control kind, must be deemed borderline absurd.

Yet, we seem to prefer the mathematical explanation of social phenomena, and the

more complex the explanation, the better. Our relentless quest for intricate mathematicalmodels (to imitate physics) turns into a sort of academic joust, in which one seeks to confirm

ones claim to knighthood.

(IV) The axiom, that by proving one thing, we also disprove its opposite. Simply put, this

is the gospel that fuels the immense (and still burgeoning) literature of event studies. By

proving that randomly selected shocks do not, statistically, show up as events, we let loose

several generations of researchers on the same database, who have been arguing most of the

time that what does measure on a statistical scale as an event is indeed a universal occurrence.

(V) The axiom that unrealistic assumptions that lead to (economically) rational con-

clusions can be useful in building theories (what one may call the Friedman doctrine). This

says that the alternative of more realistic assumptions (assumptions that correspond to

observable facts) but which do not lead to the development of theories consistent with the

logic of the homo economicus and/or which are not presentable in mathematical terms is

worthless. For the sake of this universal truth, we are willing to consider a limitless volume

of literature that seems to generate itself for its own perpetuation, thus serving the fame and

fortune of its promoters. This occurs without the slightest effort to apply some if not all the

Popperian or any other philosophy of science criteria for what contributes to the growth of

scientific knowledge.19 This axiom has been the basis of a mushrooming literature in which

the assumption of homogeneous expectations of investors plays a cardinal role, though no

academics (and certainly not finance professionals) would accept the idea that this is indeedobservable human behavior. Not only do we have no understanding how expectations are

formed, but also we have no mechanism to convert individual expectations into something

that is communal.20

Kuhns (1970) theory is cleverly used by the few who make the pretense to care about

issues of methodology to serve the purpose of the status quo. The argument that a revolution

eventually will come might be consistent with historical facts, but it disregards the social and

other costs incurred during the period needed for such reformation of thinking to occur. Even

if the axioms that are seen are seriously challenged, what is unseen is more powerful and

19 The only exception is in Fama (1998) where one principle of Lakatos is cleverly used, out of context (see

above) to immunize the EMH/CAPM against all possible refutation.20 See Frankfurter and McGoun (1996, pp. 3544) for a detailed critique of the Friedman Doctrine.



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more inhibiting to change. Consequently, R.H. Coases (1992) seemingly optimistic

contention that:. . . a scholar must be content with the knowledge that what is false in what he says will

soon be exposed and, for what is true he can count on ultimately seeing it accepted . . .

(Coase, 1992, p. 719)

is clouded by his own ill-disguised skepticism: . . . if only he lives long enough.

It is not difficult to see that the assumptions Sharpe (1964) and others make when they

develop their CAPMs, and Famas (1965, 1970) when he created the EMH, would have never

been possible without the foundation laid by the VM axioms. Just to mention such follies as

the idea of homogeneous expectations and good estimates of intrinsic values with respect

to the CAPM and EMH, respectively, would be sufficient to deem both irrational.21

In both theoretical and empirical work, in addition to assumptions piled on top of the

axioms, there are two more problems that compound the delusion of the paradigm:

1. Some previously acknowledged assumptions upon which the new work is based, which

may or may not be valid, are taken for granted and are not even mentioned.

2. The assumptions of the statistical model used to validate or reject a null hypothesis are

not seriously considered or adhered to.22

Now comes any new frame of work that is basically a serious and well-deserved questioningof the axioms and indirectly of all the work of the orthodoxy. Whether it is empirical evidence

about the incorrectness of the paradigm or a newly created theory such as BF, the way to

proceed in the interest of growth in scientific knowledge is to let the competing rationales run

their course in parallel. Instead, the promoters of accepted dogma, the guardians of the faith,

try everything to discredit the emerging new way of thinking. Accordingly, reducing evidence

and theory to the level of an anomaly, or just a dustbin of anomalous results, takes the fight

against progress into an intellectual level that discourages new minds to join the fray. The

power of language is mightier than the sword, and the elite of the old religion is very

comfortable with manipulating it. It has been efficiently used for decades now.

7. Conclusion

In his comments on Kleidons (1987) article, which we discussed extensively in Section 3,

Robert Shiller (1987) makes the following statement:

Perhaps what we need is not something so dramatic as a scientific revolution so much as a

little softening of the dogmatic adherence to the efficient markets viewpoint among people in

21 As the story is told in several places, Sharpes (1964) paper was originally rejected by The Journal of

Finances editor on the grounds that the assumption of homogeneous expectation was called by the reviewer of the

paper preposterous, and the editor fully concurred with the reviewer.22 The most glaring is disregarding the requirement of normality of the data, which can rarely if ever be verified.



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academe. If you look in finance journals, you will find a nearly total absence of any

mention of the possibility that fashions or fads may be at work. Those who bring up such a

possibility are viewed as if they were bringing up astrology or extrasensory perception. I

find that, as a consequence, many people in academic finance show little indication of

having thought much about how fashions or fads might affect financial markets (Shiller,

1987, p. 317).

To this, we would add that what finance really needs is a healthy infusion of the very

sort of science that it portrays itself as practicing. First, it ought to be more attentive to

its philosophy. It should be clear from the numerous quotations from Kuhn in this paper

that he is not very precise about just what an anomaly is. However, it should be

equally clear from our discussion in this paper that where finance has made reference to

Kuhn, it has clearly done so in its own interests. It uses the word anomaly in what ison the whole its general sense in order to disparage what ought to be taken as serious

evidence against the EMH and CAPM, and it borrows Kuhns more dismissive

comments on anomalies to give the semblance of philosophical respectability to what

it is doing.

Second, finance ought to be more attentive to its language in general. Although it

purports to be objective, it clearly uses words that are subtly dismissive of alternatives to its

most cherished theories. Even finances critics contribute to their own downfall. It is not

surprising that Kleidon should contrast rational expectations with mass psychology

and fads. However, if Shiller expects BF ever to be taken seriously, it cannot continue tobe described as advocating the relevance of fashions and fads. Of course, it is hard to

imagine a term for markets that could possibly compete with efficiency, now that that

term has been adopted for what previously had been not nearly so attractively referred to as

a random walk.

The case of the word anomaly in many ways encapsulates the current status of

research in finance. Traditional finance has immunized itself from criticism by ensuring

that its novices in doctoral programs receive a limited education in its own bastardized

version of the philosophy of science and by clothing itself in terms that are so

attractive and its opposition in terms that are so disparaging. Real progress in finance

can only be achieved when such matters are recognized for what they are and

critically examined.

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