But this idea relied on the presumption that the world is basically stationary, that the future is pretty much the same as the past, that we can extrapolate from relatively small samples, and that there is a single “data generating process” that we can identify and understand. But we know that the real world is more complex.
The determinants of asset prices are not fixed, but vary over time. Asset returns do not follow a normal distribution, as it is assumed by conventional valuation formulas. Myopic behaviour, herding and other types of distorted incentives on the part of individuals and financial institutions can generate negative externalities and move financial markets’ expectations and risk premia away from fundamentals.