EMH

Rightwing

Efficient Market Hypothesis.

So which of these economists is right ?

Eugene Fama’s academic career is built on the efficient market hypothesis (EMH), dismissed by Robert Shiller as “one of the most remarkable errors in the history of economic thought”.
Little wonder eyebrows were raised when both were last week awarded the Nobel memorial prize in economics for their analysis of asset prices. Few dispute Shiller’s credentials, given his timely warnings on the dotcom and housing bubbles.

KyussBishop

Well, the empirical basis of the Efficient Market Hypothesis is so lacking, to the point that it can safely be discarded - too much of modern economics, is built upon theory which doesn't hold up to empirical scrutiny (and when faced with contradicting evidence, many economists unfortunately try to pretend that evidence does not apply to their theory).

So, you don't judge the merit of theories like this based on notoriety of the people involved, but on the evidence.

Rightwing

KyussBishop wrote: »

Well, the empirical basis of the Efficient Market Hypothesis is so lacking, to the point that it can safely be discarded - too much of modern economics, is built upon theory which doesn't hold up to empirical scrutiny (and when faced with contradicting evidence, many economists unfortunately try to pretend that evidence does not apply to their theory).

So, you don't judge the merit of theories like this based on notoriety of the people involved, but on the evidence.

I tend to agree, perhaps it is inherently flawed because it overlooks interference from c banks/govts.

KyussBishop

Steve Keen did some good writing on it in his Debunking Economics book, but EMH is a theory I only have a passing familiarity with, so I can't replicate his arguments nearly as well.

The problem in general with EMH, is the assumptions it relies upon can never apply in reality: It is not possible to have perfect sharing of information, and this most definitely does not exist in reality.

It expects people in the stock market, to 1: both all carry the same assumptions about the future price of stocks, and 2: that these assumptions always actually come about in reality (which of course, in reality this is not the case).
Basically, it expects people to be able to accurately predict the future; to be prescient.

There's even a part of the chapter on the EMH specifically referencing Fama, showing that Fama himself has posted criticism of the Capital-Asset Pricing Model, which is derived from EMH (Keen says through this, Fama is effectively disowning EMH); here is a summary I found while searching:
https://williampaulbell.wordpress.com/2010/01/15/capital-asset-pricing-model-capm-and-efficient-market-hypothesis-emh-contributing-to-the-global-financial-crisis-gfc/


I'm really not up to speed on the minutiae of the arguments surrounding this topic though, so it would take me a long while of reading to understand the arguments well enough, to go into more detail, rather than just give this very basic overview.

Rightwing

KyussBishop wrote: »

Steve Keen did some good writing on it in his Debunking Economics book, but EMH is a theory I only have a passing familiarity with, so I can't replicate his arguments nearly as well.

The problem in general with EMH, is the assumptions it relies upon can never apply in reality: It is not possible to have perfect sharing of information, and this most definitely does not exist in reality.

It expects people in the stock market, to 1: both all carry the same assumptions about the future price of stocks, and 2: that these assumptions always actually come about in reality (which of course, in reality this is not the case).
Basically, it expects people to be able to accurately predict the future; to be prescient.

There's even a part of the chapter on the EMH specifically referencing Fama, showing that Fama himself has posted criticism of the Capital-Asset Pricing Model, which is derived from EMH (Keen says through this, Fama is effectively disowning EMH); here is a summary I found while searching:
https://williampaulbell.wordpress.com/2010/01/15/capital-asset-pricing-model-capm-and-efficient-market-hypothesis-emh-contributing-to-the-global-financial-crisis-gfc/


I'm really not up to speed on the minutiae of the arguments surrounding this topic though, so it would take me a long while of reading to understand the arguments well enough, to go into more detail, rather than just give this very basic overview.

Thanks, I must have a read of that. The CAPM is certainly flawed.

qmzp

KyussBishop wrote: »

Steve Keen did some good writing on it in his Debunking Economics book, but EMH is a theory I only have a passing familiarity with, so I can't replicate his arguments nearly as well.

The problem in general with EMH, is the assumptions it relies upon can never apply in reality: It is not possible to have perfect sharing of information, and this most definitely does not exist in reality.

It expects people in the stock market, to 1: both all carry the same assumptions about the future price of stocks, and 2: that these assumptions always actually come about in reality (which of course, in reality this is not the case).
Basically, it expects people to be able to accurately predict the future; to be prescient.

There's even a part of the chapter on the EMH specifically referencing Fama, showing that Fama himself has posted criticism of the Capital-Asset Pricing Model, which is derived from EMH (Keen says through this, Fama is effectively disowning EMH); here is a summary I found while searching:
https://williampaulbell.wordpress.com/2010/01/15/capital-asset-pricing-model-capm-and-efficient-market-hypothesis-emh-contributing-to-the-global-financial-crisis-gfc/


I'm really not up to speed on the minutiae of the arguments surrounding this topic though, so it would take me a long while of reading to understand the arguments well enough, to go into more detail, rather than just give this very basic overview.

Steve Keen's book is a joke. He completely mis-interprets EMH and incorrectly asserts that a failure of the standard CAPM is a violation of EMH. He is a grade-A crank.

andrew

There was a good article in the FT about this, by Steven Levitt. Basically one of the points he made (which I think was good) was that the EMH is a good starting point from which to analyse market behaviour. Coming up with a hypothesis and stating what assumptions are necessary to maintain that hypothesis, allows you to rigorously relax those assumptions and then see what should follow from that.

KyussBishop

qmzp wrote: »

Steve Keen's book is a joke. He completely mis-interprets EMH and incorrectly asserts that a failure of the standard CAPM is a violation of EMH. He is a grade-A crank.

It's based on them both utilizing many of the same assumptions, and showing the refutation of CAPM limits the remaining ways in which EMH can still apply.

KyussBishop

andrew wrote: »

There was a good article in the FT about this, by Steven Levitt. Basically one of the points he made (which I think was good) was that the EMH is a good starting point from which to analyse market behaviour. Coming up with a hypothesis and stating what assumptions are necessary to maintain that hypothesis, allows you to rigorously relax those assumptions and then see what should follow from that.

The problem with this, is a common problem in economics, the idea that "assumptions don't matter" - which Friedman advocated, but which is actually one of the most fundamentally wrong things about a lot of economics.

Some good articles on it here (first one touching on EMH as well):
https://unlearningeconomics.wordpress.com/2013/02/08/against-friedman-why-assumptions-matter/
https://unlearningeconomics.wordpress.com/2011/12/01/milton-friedmans-methodology-a-critique/

qmzp

KyussBishop wrote: »

It's based on them both utilizing many of the same assumptions, and showing the refutation of CAPM limits the remaining ways in which EMH can still apply.

Not true. Of the two assumptions you mention in a previous post, the first is true of the CAPM only, and the second is true of neither. A breach of EMH can violate the assumptions of the CAPM, but not vice versa. Look for better sources.

KyussBishop

Except I didn't say it violates EMH, I said it limits it; better explained here:
http://business.time.com/2009/10/08/what-we-talk-about-when-we-talk-about-the-efficient-market-hypothesis/

qmzp

KyussBishop wrote: »

Except I didn't say it violates EMH, I said it limits it; better explained here:
http://business.time.com/2009/10/08/what-we-talk-about-when-we-talk-about-the-efficient-market-hypothesis/

We can only test EMH by assuming a model. It's called the "dual-hypothesis" problem. The failure of the CAPM doesn't weaken/limit EMH unless you think the CAPM is the only plausible model of expected returns - it's not. Nothing I have said is any different from what was known 40+ years ago.

KyussBishop

Ok, I'll certainly say that Keen's taking of EMH and CAPM in the same breath is misleading (though I don't think intentionally so - I'll need to reread that), regardless of the applicability/inapplicability of EMH.
What is your view on EMH? (if you support it, can you define what version of it you support - as it seems to have a variety of forms)

qmzp

KyussBishop wrote: »

Ok, I'll certainly say that Keen's taking of EMH and CAPM in the same breath is misleading (though I don't think intentionally so - I'll need to reread that), regardless of the applicability/inapplicability of EMH.
What is your view on EMH? (if you support it, can you define what version of it you support - as it seems to have a variety of forms)

The forms of EMH come from the set of information you want to test. There are three common types of test. Weak form tests consider only the set of past price changes. Semi-strong form tests consider all public information. Strong form tests consider all information, public and private.

Weak-form efficiency in stock markets has a lot of evidence behind it. Trying to predict prices using trends, moving averages, etc., will be incredibly difficult. Andrew Lo has some nice work suggesting that may not be hopeless. Semi-strong form can't be reliably tested as there are many different asset-pricing models; there are popular models, but there is no consensus. Strong-form efficiency is almost certainly wrong.

Shiller is to be applauded for moving the debate towards psychological issues and bubbles, but the argument against him is that he is constantly pessimistic and bound be right eventually. People might trade on irrelevant information or on a whim. The influence this has on market prices will be important unless others trade against it. The ability of other traders to do this is vitally important. The type of market will also be very important, e.g., it may be very difficult during a property boom.

KyussBishop

From what I can tell, the weak form EMH is basically the 'random walk hypothesis' (that market prices move in a random fashion and are unpredictable - seems to fit, as Andrew Lo, who you mention, is in that article), and this does seem to have issues too.

On the semi-strong version, indeed it doesn't seem possible to reliably test - and I think this would put it into question, as any hypothesis should (in my view - whether it needs to be combined with other hypothesis, e.g. an asset price theory, or not) - should be able to provide testable/falsifiable predictions, in order to be considered useful.

It's an interesting topic overall (theories of price movements in markets), though not one I've really read much on overall.

qmzp

KyussBishop wrote: »

From what I can tell, the weak form EMH is basically the 'random walk hypothesis' (that market prices move in a random fashion and are unpredictable - seems to fit, as Andrew Lo, who you mention, is in that article), and this does seem to have issues too.

You can think of them as equivalent to get the general idea, but they are subtly different.