Efficiently Inefficient

Efficiently Inefficient describes the key trading strategies used by hedge funds and demystifies the secret world of active investing. The book combines the latest research with real-world examples and interviews with top hedge fund managers to show how certain trading strategies make money and why they sometimes don't.

I view markets as neither perfectly efficient nor completely inefficient. Rather, they are inefficient enough that money managers can be compensated for their costs through the profits of their trading strategies and efficient enough that the profits after costs do not encourage additional active investing. Understanding how to trade in this efficiently inefficient market provides a new, engaging way to learn finance. The book analyzes how the market prices of stocks and bonds can differ from the model prices, leading to new perspectives on the relationship between trading results and finance theory. It explores several different areas in depth--fundamental tools for investment management, equity strategies, macro strategies, and arbitrage strategies--and looks at such diverse topics as portfolio choice, risk management, equity valuation, and yield curve logic.

The book's strategies are illuminated further by interviews with leading hedge fund managers Lee Ainslie, Cliff Asness, Jim Chanos, Ken Griffin, David Harding, John Paulson, Myron Scholes, and George Soros. Efficiently Inefficient demonstrates how financial markets really work.

Who Should Read the Book

Anyone interested in financial markets can read Efficiently Inefficient. The book can be read at different levels, both by those who want to delve into the details and those who prefer to skip the equations and focus on the intuitive explanations and interviews. It is meant both as a resource for finance practitioners and as a textbook for students. First, I hope that the book is useful for finance practitioners working in hedge funds, pension funds, endowments, mutual funds, insurance companies, banks, central banks, or really anyone interested in how smart money invests and how market prices are determined.

Second, the book can be used as a textbook. I have used the material to teach courses on investments and hedge fund strategies to MBA students at New York University and master’s students at Copenhagen Business School. The book can be used for a broad set of courses, either as the main textbook (as in my course) or as supplementary reading. The book can be read by students ranging from advanced undergraduates to Ph.D. students, several of whom have gotten research ideas from thinking about efficiently inefficient markets. The course webpage contains more information for students and professors.

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Chinese translation




Japanese translation


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For Students and Professors

Exercises: free download

Course website

Reviews and Press

CFA Institute: Book review by Fridson, 2016: "encyclopedic in its cataloging of active management strategies and authoritative in its analysis of the practical issues of their implementation. Pedersen grounds his exposition in landmark scholarly articles."

Journal of Quantitative Finance: Book review by Pekkala, 2016

Investing by the Books: Book review by Larsson, 2016

Two Plus Two Magezine: Book review by Willet

Business News Network: Top financial reads of 2015

ETF Swedroe: A Must-Read For Serious Investors

BI and SF Chronicle: These are books Wall Street's smartest people think you should read this summer (#2)

Cliff's perspective and ValueWalk: Efficient Inefficiency: The Oxymoron That Explains the Investing World. Quote: "From now on, there are two kinds of investors: the efficiently inefficient ones and the merely inefficient ones who didn’t read this book."

Institutional Investor: Are Markets Efficient or Irrational? Actually, a Bit of Both

Pensions&Investments: Hedge fund gurus guide new trading book

The Chronicle Journal: Learn strategies to help beat the market: "For serious investors I can't think of any book better for describing market beating strategies than Lasse Heje Pedersen's new book. Pedersen's pedigree combines the best of academic and finance industry qualifications."

Investor Strategy News, Australia: The art of short selling and other insights from the gurus

The Insto Report: What I am reading now: Efficiently Inefficient

Frankfurter Allgemeine: read in German. Quotes: "This is an exceptionally interesting book because it combines the skills of a modern, theoretically savvy financial economist, educated at first-rate universities, with many years of experience in a major hedge fund (AQR)", "It is a Manifesto, showing how Financial Economics operate: the financial markets are neither completely efficient, nor completely inefficient, and the inefficiencies are less the result of animal spirits, but the result among other things of liquidity shortages and the lack of collateral."

FinansWatch: (in Danish) Book: The fully efficient or inefficient market does not exist, and Classic hedge fund strategies: this is how you get rich - maybe

TV and Radio

CNBC: watch video

MoneyLife radio show: play audio

Trend following radio: play audio

Book signing at Princeton University: watch video

Millionaerklubben radio: play audio in Danish

From the Back Cover

This valuable and intriguing book provides a contemporary survey of investments across a wide spectrum of asset classes and strategies. Combining a wonderful narrative with a rigorous analytical structure, Efficiently Inefficient serves the needs of students, serious investors, and professionals. It is an important contribution to the investment literature. Gary P. Brinson, CFA, GP Brinson Investments

For a book on investments, Efficiently Inefficient sets a completely different and higher standard. Pedersen blends the best and latest research, accessible to both MBA students and professionals, with the insights of some of the world's leading hedge fund managers. It works beautifully. Darrell Duffie, Stanford University

Efficiently Inefficient is a truly modern and masterful introduction to how finance will be studied and practiced in the twenty-first century. Andrei Shleifer, Harvard University

How are markets efficient enough to stump most investors, yet inefficient enough to allow hedge fund managers to earn huge profits? Lasse Pedersen, who has contributed greatly to the 'new finance' of liquidity and financial frictions, answers this question with a tour-de-force combination of original research and provocative interviews with hedge fund managers. Laurence B. Siegel, CFA Institute Research Foundation

Lasse Pedersen is a gifted financial market theorist who understands that theory is most satisfying when it is combined with a deep practical understanding of institutional detail and market frictions. This terrific book showcases his strengths in all of these dimensions. Jeremy Stein, Harvard University, former Governor of the Federal Reserve System

This accessible book explains hedge fund strategies and how to design, construct, evaluate, implement, and risk manage them. The section on securities lending and borrowing is interesting and novel, and Pedersen’s discussion of macro and central bank strategies is one of the best I have seen in any book on hedge funds. His account of portfolio construction is superior. Robert Kosowski, Imperial College Business School

Efficiently Inefficient bridges academic finance and the practice of finance. Students will appreciate the insights of top investment managers and the sections on transactions costs and liquidity are especially valuable. I will use the book in my graduate course on investment and I highly recommend it to all those working in the investment management industry. Campbell R. Harvey, editor of the Journal of Finance (2006–2012)

Table of Contents

The Main Themes in Three Simple Tables


Introduction (free download subject to the copyright of Princeton University Press)

Part I Active Investment

Chapter 1 Understanding Hedge Funds and Other Smart Money

Chapter 2 Evaluating Trading Strategies: Performance Measures

Chapter 3 Finding and Backtesting Strategies: Profiting in Efficiently Inefficient Markets

Chapter 4 Portfolio Construction and Risk Management

Chapter 5 Trading and Financing a Strategy: Market and Funding Liquidity

Part II Equity Strategies

Chapter 6 Introduction to Equity Valuation and Investing

Chapter 7 Discretionary Equity Investing

Interview with Lee S. Ainslie III of Maverick Capital

Chapter 8 Dedicated Short Bias

Interview with James Chanos of Kynikos Associates

Chapter 9 Quantitative Equity Investing

Interview with Cliff Asness of AQR Capital Management

Part III Asset Allocation and Macro Strategies

Chapter 10 Introduction to Asset Allocation: The Returns to the Major Asset Classes

Chapter 11 Global Macro Investing

Interview with George Soros of Soros Fund Management

Chapter 12 Managed Futures: Trend-Following Investing

Interview with David Harding of Winton Capital Management

Part IV Arbitrage Strategies

Chapter 13 Introduction to Arbitrage Pricing and Trading

Chapter 14 Fixed-Income Arbitrage

Interview with Nobel Laureate Myron Scholes

Chapter 15 Convertible Bond Arbitrage

Interview with Ken Griffin of Citadel

Chapter 16 Event-Driven Investments

Interview with John A. Paulson of Paulson & Co.


Market Liquidity

Market Liquidity: Asset Pricing, Risk, and Crises by Yakov Amihud, Haim Mendelson, and Lasse Heje Pedersen, Cambridge University Press, 2013.

This book is about the pricing of liquidity in securities markets. The authors present theory and evidence on the positive effect of liquidity on asset prices, why liquidity varies over time, and how liquidity risk affects prices. The book then explains how liquidity crises create downward price and liquidity spirals. The analysis has implications for traders, risk managers, performance evaluation, economic policy, regulation of financial markets, management of liquidity crises, and academic research.

Reviews and Endorsements

pivotal in furthering our understanding of the effects of illiquidity on asset pricing. Robert Korajczyk's review in Quantitative Finance.

These authors were writing and teaching about the importance of understanding liquidity way before we all learned more about it than we cared to. They have made major contributions to understanding the real, not purely theoretical, world that investors face every day. Gathering their seminal work in one place along with updated perspectives and overviews is a serious contribution, Cliff Asness, AQR Capital Management

Over the past quarter century, the research contributions of Amihud, Mendelson, and Pedersen have been central to an understanding of the determinants and pricing of market liquidity and liquidity risk. This collection places the best available work on the topic between two covers. It must be read by anyone following this subject area. Darrell Duffie, Stanford University

The liquidity of financial markets has never been a more important topic of research and policy and this book gives a very accessible way to understand both the traditional and current research. The book reproduces eight papers that range from the seminal work that defined the field starting in the 1980s to the recent research based on the analysis of the financial crisis. A particular feature of the book is the series of extended introductions to each of the papers, written nontechnically to summarize each paper and how it fits into future research - they will transport you to a first rate graduate classroom. Robert Engle, Nobel Laureate and Director, Volatility Institute, New York University

The term 'market liquidity' means different things to different people at different times. Distinguishing, defining, and measuring the different meanings is an important activity, especially now, after four years of financial crises. This collection of scientific papers by eminent scholars is an important contribution to understanding market frictions and arrangements to manage them. Thomas Sargent, Nobel Laureate, New York University