I'm having an interesting discussion with my professor on EMH and I'm trying to show him the failure of EMH to explain bubbles. He's taking the position that the price of the assets at the height of the bubble took into account all known information. When new information was known the market adjusted. I've mentioned low interest rates, but have stopped short of fully explaining ABCT.
Anyway, my question to you guys is...in a pure laissez faire economy with no fed distortions, no regulations etc, would you buy into the efficient market hypothesis? That is would you beat the market half the time and fail to beat it the other half? If you consistently earn a higher return than the market, would just call that luck?
At least he wasn't a Keynesian!
To piggyback on this post, I am also curious if there is a distinction between the Efficient Market Hypothesis and Efficient Market Theory, or if they are one and the same. My search leads me to believe that EMH and EMT are one in the same, although I rarely hear the latter used.
Ya I've never heard it termed efficient market theory.
If you can kindly explain why everyone would beat the market half the time, then I might buy into it. As is, it sounds pretty silly.
Of course we can test it by going to ESPN.com and checking if their experts predicted game outcomes about 50% of the time. If they didn't that would kill the EMH, no? If they did, it would need further testing, and even more, a solid reasoned explanation.
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Are we talking about the weak or strong version of the EMH? I would support the weak version in a completely free economic system.
"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."
Smiling Dave: If you can kindly explain why everyone would beat the market half the time, then I might buy into it. As is, it sounds pretty silly. Of course we can test it by going to ESPN.com and checking if their experts predicted game outcomes about 50% of the time. If they didn't that would kill the EMH, no? If they did, it would need further testing, and even more, a solid reasoned explanation.
The theory goes that markets (particularly stock markets) price in all available information. This means that you don't have any more information to base your investment decisions on than the millions of other people pouring over the data. The implication is that for a given level of risk, in the long run you will be unable to earn a higher return than the market average. So if market has a beta of 1.0 and a return of 8%, you may earn either above 8% or less than 8% on a particular stock with similar risk, but in the long it will average out to 8%. Again, if you don't have any different information than the millions of other investors, how can you consistently earn a higher return than them?
1. So there is no such thing as insider trading?
2. So all people are equally intelligent? And they all think the same way? Why is there ever any disagreement about anything at all, seeing as we all have the same information? Why do debates not end with one side conceding every single time?
3. Bottom line, there are two assumptions that I don't see the evidence for. That everyone has identical information, and makes the same use of it.
markets price in all available information that people act on, not all available information. That is the crucial distinction.
Smiling Dave: 1. So there is no such thing as insider trading? 2. So all people are equally intelligent? And they all think the same way? Why is there ever any disagreement about anything at all, seeing as we all have the same information? Why do debates not end with one side conceding every single time? 3. Bottom line, there are two assumptions that I don't see the evidence for. That everyone has identical information, and makes the same use of it.
1. This would imply the "strong form" of the hypothesis. Obviously insider information takes time to filter through to the entire market. Which is why I would reject the strong form.
2. It doesn't assume that everyone acts the same. In fact it's exactly the opposite. Some people will price the stock below the market average and sell, others will prices it above the average and buy. This is how market prices are formed. But it suggests that half will be right and earn an above average return, and half will be wrong and earn a below average return.
3. Again this implies strong form. I think the real question is whether it is weak and semi-strong form.
It doesn't assume that everyone acts the same. In fact it's exactly the opposite. Some people will price the stock below the market average and sell, others will prices it above the average and buy. This is how market prices are formed. But it suggests that half will be right and earn an above average return, and half will be wrong and earn a below average return.
1. What is the basis for assuming that half will be right and half will be wrong?
2. The OP seems to be saying that no one can beat the market, because the law of averages will make sure he is wrong half the time.
I don't see any basis for such an assumption. We may all have the same information, but some people know what to do with it.
As a simple example, some people have been saying for years that gold will go up up , up, and giving their reasons. Does the EMH say they were just lucky? That they may think they know what they are talking about, but they really don't?
Smiling Dave: I don't see any basis for such an assumption. We may all have the same information, but some people know what to do with it.
Couldn't one make the claim that the ones who know what to do with it will drive the ones who don't out of the market? Wouldn't that mean that the only people remaining would be the ones who know what to do with the information? If that is the case how can one of these individuals beat the rest on average?
Your gold example isn't a very good one because government policy distorts market fundamentals. We are assuming pure laissez faire here.
Chris Pacia: Smiling Dave: I don't see any basis for such an assumption. We may all have the same information, but some people know what to do with it. Couldn't one make the claim that the ones who know what to do with it will drive the ones who don't out of the market? And how long will that take? Remembering P.T. Barnum's maxim, there are always new suckers, so it will never happen. Wouldn't that mean that the only people remaining would be the ones who know what to do with the information? If that is the case how can one of these individuals beat the rest on average? So the EMH is only applicable if it assumes smart players? All equally smart? All equally smart and equally informed about all the many thousands of stocks? What connection does this have to reality? So there is no Warren Buffet? He is just a product of dumb luck? It really boggles the mind to see this taken seriously. Your gold example isn't a very good one because government policy distorts market fundamentals. We are assuming pure laissez faire here. 1. So the EMH has no application in the world as we live it? They are all speaking about a fantasy world where there is no govt? 2. I don't see why govt policy distorting fundamentals should change the argument. The existence of the govt is not a secret. Everyone has that info. In fact you seem to be making my case stronger, by saying that the guys who said gold would go up could not have known what they were talking about, cause the govt distorted things. So you seem to be saying that of course it was dumb luck, and their well thought out reasons, publicly displayed, are just the typings of monkeys. I don't buy it.
Couldn't one make the claim that the ones who know what to do with it will drive the ones who don't out of the market?
And how long will that take? Remembering P.T. Barnum's maxim, there are always new suckers, so it will never happen.
Wouldn't that mean that the only people remaining would be the ones who know what to do with the information? If that is the case how can one of these individuals beat the rest on average?
So the EMH is only applicable if it assumes smart players? All equally smart? All equally smart and equally informed about all the many thousands of stocks? What connection does this have to reality? So there is no Warren Buffet? He is just a product of dumb luck? It really boggles the mind to see this taken seriously.
1. So the EMH has no application in the world as we live it? They are all speaking about a fantasy world where there is no govt?
2. I don't see why govt policy distorting fundamentals should change the argument. The existence of the govt is not a secret. Everyone has that info.
Everyone does not have the same info when dealing with government. If they did then everyone would have avoided investing in the housing market knowing that Fed policy was just creating an unsustainable boom. How can you possibly make that claim? Same thing with gold. If everyone knows impact of the fed's policies then people would have invested in gold years ago.
The EMH wikipedia entry suggests that EMH is related to financial markets, but not necessarily markets.
The EMH is merely the application of Rational Expectations to financial markets. It basically says that markets price better than individuals (because of arbitrage). If individual's continuously "beat the market," in the average, then it would mean that individuals are better at pricing assets than the market (beating the market should be a random occurrence). In other words, it would mean that markets are inefficient. I believe that this theory only holds (the weak version) when there isn't continuous government intrusion within markets, especially within money and capital markets. The strong version of the EMH is demonstrably false and it makes no sense (prices represent "intrinsic" values).