Thaler examines the role of behavioral economics in financial markets, an area initially deemed resistant to behavioral biases. He emphasizes the high stakes and rigorous professional trading in these markets, where any irrational behavior by non-experts or even experts should theoretically be swiftly corrected, leaving no trace on market prices. The prevailing view among economists was that financial markets were the least likely place for behavioral anomalies to be found, which meant demonstrating their presence there would be a significant achievement.

This chapter examines the Efficient Market Hypothesis (EMH), coined by Eugene Fama, which is central to financial economics. The EMH asserts that financial markets efficiently incorporate all available information into asset prices, making it impossible to consistently outperform the market. Thaler challenges this by focusing on market anomalies and investor behavior that contradict the EMH.

One significant concept from this chapter is the “Beauty Contest” analogy by John Maynard Keynes, which compares stock market investment to a contest where participants pick not the faces they find prettiest but those they believe will be chosen by others. This analogy illustrates the recursive thinking involved in financial markets, where investors try to anticipate the average opinion of all investors.