Searching for alpha is searching through inefficiency because there are no supernormal returns in efficiency. This seems intuitive and correct because there is a cost to searching through inefficiency. And agents who spend that cost have to be rewarded for that effort. The case for inefficiency is unassailable.

Subjective Inefficiency

The case for what causes inefficiency, what explains it, has been simplified by the behavioral economists, using behavioral reasons for anomalies (cases of inefficiency). Unfortunately, this has lead to the subject becoming more of a subjective discourse rather than something objective. Ideas like anomalies are here to stay, markets can’t be predicted, but some forms of extreme anomalies can be profited from lead to the idea of behavioral funds.

Behavioral Finance Funds

The Journal of Asset Management featured, “Are behavioral finance equity funds a superior investment?” in April 2013.

U.S. behavioral funds outperformed during bull markets but underperformed in bear markets. The funds don’t outperform passive benchmarks; they do outperform active funds in general. The feature suggested that either stock markets are more efficient, or fund management is worse than behavioral funds advertise. Adjusted for risk, behavioral funds were tantamount to value investing. There was no clear evidence of outperformance on a risk-adjusted basis. Behavioral finance fund performance proved that anomalies can’t be identified and exploited on a persistent basis and costs could be a partial contributor.


If behavioral funds are like fundamental funds where does this lead us? This tells us that anomalies that behavioral finance is trying to exploit are like deep value. And for fundamentalists, this means that value has something to do with behavioral biases. The idea of reversion in value also becomes a commonality for both value and behavior.

Both fundamentalists and behavioral economists underplay the idea of reversion. The idea of factors assumes more importance for Fama and French (SMB and HML). Fama and French assume factors drive reversion (factor premium), while behavioral economists believe behavioral anomalies drive reversion. Are both of them correct? Is one of them correct? Or are both of them wrong? Reversion can be explained by factors and behavioral aspects, and maybe by many more reasons. The truth is that reversion is a reality more important than factors.


Fama’s words “ we don’t know why factors work”. Behavioral Finance does not focus on the reasons driving anomalies. They are happy illustrating them rather than understanding or question what drives behavior.

Winners’ Curse

…and Gambler’s fallacy are the top behavioral biases. Winner’s curse is when the agent has a flawed expectation of premium, which fails to materialize owing to the regression to mean. The behavioral winner is cursed (biased) because he pays more premium for something that is ordered to reverse.

Gambler’s fallacy (bias) on the other hand is an expectation of reversal when things are random. In other words, reversion and momentum are probabilistic, so just because things are in momentum, the chance for reversion does not increase or vice versa.

Winner’s curse and Gambler’s fallacy the pillars of behavioral finance biases can be reframed as a statistical question. What is the probability of reversion? What is the probability of momentum? What is the probability of reversion transforming to momentum and vice versa?

If we can set a proxy which explains the above three questions then we have a better explanation than what Fama and French and behavioral biases offer today. And behavioral biases just like Fama said still seems like a storytelling built around anomalies.