Let’s not quote EY as gospel on this topic. There are a lot of people who say lots of things about the market, and unless something is supported by theorems or solid empirical data rather than handwaving, I’m reluctant to adopt it as a quotable principle.
Err… That isn’t EY making stuff up. It is supported by theorems. That is the efficient market hypothesis described in different language. You can deny that a given market is efficient but that is you handwaving away the theorems.
And FWIW, I have a very smart friend who makes a ton of money playing the stock market and part of what he does is look for patterns and exploit them.
This isn’t implausible. It can come about from any one of:
Your friend is smarter than the people he is trading with.
Your friend has happened to be lucky.
Your friend is using practices that concentrate risk. (ie. He is one of the countless traders using strategies that give ongoing steady returns with a small chance of being completely wiped out in a day.)
I don’t think the efficient market hypothesis is universally accepted among economists. Correct me if I’m wrong though.
What’s your support for the assertion about “countless traders” using practices that concentrate risk? It does seem intuitively plausible, but is there serious scholarly support for this idea?
I don’t think the efficient market hypothesis is universally accepted among economists.
So, there’s a continuum of EMHs from the strong-but-probably-false “markets react instantly to information” to the weak-but-more-plausible “markets on average tend to react to publicly available information, perhaps after some lag.”
As that suggests, more economists accept the weaker forms than the stronger forms.
I don’t think the efficient market hypothesis is universally accepted among economists.
The scope for disagreement is on to what degree a particular market is efficient (and what form of efficiency there is). Many markets (particularly smaller ones) are far from efficient and strong-form efficiency (where it isn’t even possible to make money based off insider information) more or less have to be contrived scenarios. The markets are anti-inductive post that is being discussed roughly speaking only claims that markets have pressures pushing in the direction of efficiency. John’s claim is a little stronger, claiming that the particular market under discussion is likely to be more efficient than you are.
The heavily traded global markets that we have now are not perfectly efficient. It is clear however that they are sufficiently close to efficient that extracting money from them from nothing more than historical trends in the prices is not easy.
What’s your support for the assertion about “countless traders” using practices that concentrate risk? It does seem intuitively plausible, but is there serious scholarly support for this idea?
I don’t believe I am referring to something controversial. Someone else more familiar with the nomenclature may probably more suited than I for the task of bludgeoning the principles home with authoritative references than I. All I have is an example, the famous popularisation and the name of the risk that has not been hedged against or accounted for when making this particular mistake.
I’m sure that traders ignore black swans all the time, but I was curious if you knew of, for example, a paper arguing that the majority of traders who appear to consistently get positive returns are actually exposing themselves to black swans, or a paper that tried to estimate just how common this “concentration of risk” phenomenon was.
As an aside, I wouldn’t assume there existed authoritative references on a topic without having seen the references. My take: Authoritative references constitute strong evidence. Popular books, anecdotes, and short Wikipedia pages constitute middling evidence. If middling evidence implied the near-certain existence of strong evidence, then it wouldn’t be middling evidence in the first place ;)
That is the efficient market hypothesis described in different language. You can deny that a given market is efficient but that is you handwaving away the theorems.
The efficient market hypothesis is not called the efficient market theorem because it isn’t a theorem. The various efficient market hypotheses are at best mostly true: there are plenty of markets clearly understood to be significantly inefficient (residential real estate market) and no markets that can be proven efficient.
So you don’t have to handwave away theorems in order to not think (one or all of the many) efficient market hypothesis is true.
I have a very smart friend who makes a ton of money playing the stock market and part of what he does is look for patterns and exploit them.
This isn’t implausible. It can come about from any one of:
Perhaps we can’t resolve this issue in a short comment thread. But the suggestion that skepticism about an efficient market hypothesis (not a theorem) requires handwaving away things seems entirely disconnected from the reality of markets.
The various efficient market hypotheses are at best mostly true: there are plenty of markets clearly understood to be significantly inefficient (residential real estate market) and no markets that can be proven efficient.
I don’t deny that. In fact I call writing much the same thing in this very thread.
But the suggestion that skepticism about an efficient market hypothesis (not a theorem) requires handwaving away things seems entirely disconnected from the reality of markets.
Suffice it to say that you seem to have formed a very different impression of the nature and substance of John_Maxwell’s comments than I did. I chose to tap out silently from that conversation because I had no anticipation of any benefit coming from either continuing it or in saying why it wasn’t worth continuing. I suppose me engaging further (or perhaps even engaging this much) would serve to undermine my rare application of polite restraint.
Regarding your excessive emphasis on the ‘theorems’ word, I note that I did not describe the efficient market hypothesis as a theorem. The relevant theorems being referred to are those underpinning the description of the behavior of selfish agents (eg. VNM utility), which when combined with various permutations of assumptions about available episitemic resources imply various forms and degrees of market efficiency. (And to pre-empt the obvious accusation the preceding sentence could produce: No, I most explicitly do not conflate the theoretical reasoning about idealised agents with the hypothesis that a given market perfectly follows those idealised expectations—even the weak ones.)
I have looked through the referenced EY posts and realize in some sense the discussion on lesswrong of EMH is not the usual discussion.
It is the case that markets are “largely efficient,” and that seems to be what passes for the Efficient Market Hypothesis around here. EY suggests “inexploitability” as an alternative for efficiency in stating what is meant: if a market is efficient enough, then an actor can’t come along and have an expectation of excess returns (which the financial world refers to as “alpha”).
But of course in virtually any market you care to examine, you can see people who give every appearance of making predictably more than others in the market. Donald Trump has made more money more consistently trading real estate than most other traders. Peter Lynch, George Soros, Warren Buffett, and a host of others have made more money trading stocks and other financial instruments, and seemingly more consistently, then almost all other stock traders.
If EMH is merely “well its sort of harder than it looks to make money in a market, that is why we call it efficient” Then that is not a very strong statement at all. If in fact people can come along and consistently make more than others, then that is not an efficient market. Along EY’s terms, that market IS exploitable.
Now you or I or many others may fail to exploit it. It may be HARD to exploit. But if it is exploitable, then that is a very different situation to it not being exploitable.
By analogy I might suggest the “Incomprehensible Universe Hypothesis.” IUH suggests it is really hard to exploit the universe by having knowledge of how it works. The second law will win almost all the time. But then someone comes along and points to Albert Einstein, atomic bombs, transistors, space ships that go to the moon. Ahhh.. but risk-adjusted, those were just statistical variances, highly risky lucky guesses that paid off and are most of what we think about due to survivorship and other biases.
Or are there just some people who really can understand the universe well enough to predictably design stuff that will work? Are there some people who understand business and the markets well enough to predictably make higher returns than those they trade against in the market?
So I would submit that the only EMH that is true is this: unless you actually know more or can generate knowledge that is of a quantity and quality that beats many of those you are trading with, your investment performance will not reliably exceed market averages. We believe that there are people who do better as engineers than others, why would we not think that there are people who do better as investors, who successfully exploit the market, especially when we can name them and evaluate their investment performance over decades of time?
Err… That isn’t EY making stuff up. It is supported by theorems. That is the efficient market hypothesis described in different language. You can deny that a given market is efficient but that is you handwaving away the theorems.
This isn’t implausible. It can come about from any one of:
Your friend is smarter than the people he is trading with.
Your friend has happened to be lucky.
Your friend is using practices that concentrate risk. (ie. He is one of the countless traders using strategies that give ongoing steady returns with a small chance of being completely wiped out in a day.)
I don’t think the efficient market hypothesis is universally accepted among economists. Correct me if I’m wrong though.
What’s your support for the assertion about “countless traders” using practices that concentrate risk? It does seem intuitively plausible, but is there serious scholarly support for this idea?
So, there’s a continuum of EMHs from the strong-but-probably-false “markets react instantly to information” to the weak-but-more-plausible “markets on average tend to react to publicly available information, perhaps after some lag.”
As that suggests, more economists accept the weaker forms than the stronger forms.
The scope for disagreement is on to what degree a particular market is efficient (and what form of efficiency there is). Many markets (particularly smaller ones) are far from efficient and strong-form efficiency (where it isn’t even possible to make money based off insider information) more or less have to be contrived scenarios. The markets are anti-inductive post that is being discussed roughly speaking only claims that markets have pressures pushing in the direction of efficiency. John’s claim is a little stronger, claiming that the particular market under discussion is likely to be more efficient than you are.
The heavily traded global markets that we have now are not perfectly efficient. It is clear however that they are sufficiently close to efficient that extracting money from them from nothing more than historical trends in the prices is not easy.
I don’t believe I am referring to something controversial. Someone else more familiar with the nomenclature may probably more suited than I for the task of bludgeoning the principles home with authoritative references than I. All I have is an example, the famous popularisation and the name of the risk that has not been hedged against or accounted for when making this particular mistake.
I’m sure that traders ignore black swans all the time, but I was curious if you knew of, for example, a paper arguing that the majority of traders who appear to consistently get positive returns are actually exposing themselves to black swans, or a paper that tried to estimate just how common this “concentration of risk” phenomenon was.
As an aside, I wouldn’t assume there existed authoritative references on a topic without having seen the references. My take: Authoritative references constitute strong evidence. Popular books, anecdotes, and short Wikipedia pages constitute middling evidence. If middling evidence implied the near-certain existence of strong evidence, then it wouldn’t be middling evidence in the first place ;)
The efficient market hypothesis is not called the efficient market theorem because it isn’t a theorem. The various efficient market hypotheses are at best mostly true: there are plenty of markets clearly understood to be significantly inefficient (residential real estate market) and no markets that can be proven efficient.
So you don’t have to handwave away theorems in order to not think (one or all of the many) efficient market hypothesis is true.
Consider Renaissance Technologies returning a compounded 34% for 11 years. What are the probabilities that this is just pure dumb luck? Consider the subpar performance of average investors. How does this fit an efficient market?
Perhaps we can’t resolve this issue in a short comment thread. But the suggestion that skepticism about an efficient market hypothesis (not a theorem) requires handwaving away things seems entirely disconnected from the reality of markets.
I don’t deny that. In fact I call writing much the same thing in this very thread.
Suffice it to say that you seem to have formed a very different impression of the nature and substance of John_Maxwell’s comments than I did. I chose to tap out silently from that conversation because I had no anticipation of any benefit coming from either continuing it or in saying why it wasn’t worth continuing. I suppose me engaging further (or perhaps even engaging this much) would serve to undermine my rare application of polite restraint.
Regarding your excessive emphasis on the ‘theorems’ word, I note that I did not describe the efficient market hypothesis as a theorem. The relevant theorems being referred to are those underpinning the description of the behavior of selfish agents (eg. VNM utility), which when combined with various permutations of assumptions about available episitemic resources imply various forms and degrees of market efficiency. (And to pre-empt the obvious accusation the preceding sentence could produce: No, I most explicitly do not conflate the theoretical reasoning about idealised agents with the hypothesis that a given market perfectly follows those idealised expectations—even the weak ones.)
I have looked through the referenced EY posts and realize in some sense the discussion on lesswrong of EMH is not the usual discussion.
It is the case that markets are “largely efficient,” and that seems to be what passes for the Efficient Market Hypothesis around here. EY suggests “inexploitability” as an alternative for efficiency in stating what is meant: if a market is efficient enough, then an actor can’t come along and have an expectation of excess returns (which the financial world refers to as “alpha”).
But of course in virtually any market you care to examine, you can see people who give every appearance of making predictably more than others in the market. Donald Trump has made more money more consistently trading real estate than most other traders. Peter Lynch, George Soros, Warren Buffett, and a host of others have made more money trading stocks and other financial instruments, and seemingly more consistently, then almost all other stock traders.
If EMH is merely “well its sort of harder than it looks to make money in a market, that is why we call it efficient” Then that is not a very strong statement at all. If in fact people can come along and consistently make more than others, then that is not an efficient market. Along EY’s terms, that market IS exploitable.
Now you or I or many others may fail to exploit it. It may be HARD to exploit. But if it is exploitable, then that is a very different situation to it not being exploitable.
By analogy I might suggest the “Incomprehensible Universe Hypothesis.” IUH suggests it is really hard to exploit the universe by having knowledge of how it works. The second law will win almost all the time. But then someone comes along and points to Albert Einstein, atomic bombs, transistors, space ships that go to the moon. Ahhh.. but risk-adjusted, those were just statistical variances, highly risky lucky guesses that paid off and are most of what we think about due to survivorship and other biases.
Or are there just some people who really can understand the universe well enough to predictably design stuff that will work? Are there some people who understand business and the markets well enough to predictably make higher returns than those they trade against in the market?
So I would submit that the only EMH that is true is this: unless you actually know more or can generate knowledge that is of a quantity and quality that beats many of those you are trading with, your investment performance will not reliably exceed market averages. We believe that there are people who do better as engineers than others, why would we not think that there are people who do better as investors, who successfully exploit the market, especially when we can name them and evaluate their investment performance over decades of time?