Talk:Efficient-market hypothesis

Terrible Analogy

The meteorological analogy is a very bad one and just serves to confuse people who do not have a strong grasp of the markets. Even if every single person in the world tomorrow says it will rain in London tomorrow, that has NO EFFECT on whether it will actually rain or not. However, if every single person thinks Google is worth US$2, guess what happens to the price of the Google? It goes straight to US$2. Regardless of the argument put forth in the following paragraph, about whether the market can be 'right', there is no denying the fact that the market can be influenced by individual's beliefs, while the weather most certainly cannot. I don't see the benefit of this analogy at all and think it should be removed.] -B —Preceding unsigned comment added by 58.152.140.7 (talk) 13:39, 15 November 2008 (UTC)

Change to definition

King Brosby, I don't know if your change here [1] made the definition of EHM more accurate, but it sure made it more confusing. I'd like to fix it but I'm not sure how - can you try? Otherwise I'll do my best. Axlrosen 21:16, 3 Oct 2003 (UTC)

Other things that need fixing:

• We need to explain that the EMH only applies to "efficient" markets, which we need to define.

• "Later work ... found that there were no significant dependences in price changes suggesting that the UK stock market was weak-form efficient." I have no idea what this is trying to say. Axlrosen 21:33, 3 Oct 2003 (UTC)

Thank you for your information. It is very useful to my study. Is it possible that I can ask you a question? for the Low P/E stocks, they tend to have positive return over the long run, do u think that it is consistent with the strong violation of the strong form of efficient market profolio?

Informational efficiency

Some observations on the definition: I would say that informational efficiency only makes sence as an equilibrium concept, i.e. characterising prices (and possibly allocations). This would imply that we are should not talk abour efficient markets, but of informational efficient prices (and possibly allocations). A definition would be something like: A set of prices is informational efficient with regards to a certain set of information if it would constitute an equilibrium even when that set of information was made available to all agents.

I would think that we would then not need a definition of informational efficient markets. But if we were to have such a definition it could be something like: A certain organisation of markets is informational efficient with regards to a certain set of information if all possible equilibria in that organisation of markets (for all combinations of agent characteristics, i.e. preferences, endowments, etc) would be informational efficient in the above sence. --Olejasz 20:40, 23 November 2005 (UTC)

EMH is controversial

The Efficient market hypothesis (and it has always been just a hypothesis) is highly controversial, especially after the stockmarket runup in the late 1990s. There is a significant amount of research that shows that markets vary in their efficiency, and that this depends on market structure and organization. Grossman and Stiglitz in their landmark academic paper "The “Impossibility of Informationally Efficient Capital Markets”" show that liquidity would be zero in efficient markets (Stiglitz is a Nobel prize winner, so is not easily discounted). Successful investors like Warren Buffet catagorically reject technical analysis in favor of fundamental analysis. Though there may still be supporters of the efficient market hypothesis, I would suggest that this hypothesis can no longer be considered mainstream. (Chris Westland, Nov. 2005)

EMH has great validity in weak and semi-strong forms, but is limited by two false assumptions: 1) EMH assumes that new information is assimilated by the markets virtually instantaneously, and 2) it assumes absolute liquidity.

When new information comes into play, there is a time lag while it is being processed. During this time delay, uncertainty about investment risk is relatively high. Overall investment risk includes all forms, including opportunity cost risk. Also, uncertainty about risk is itself risk. These facts mean that risk is volatile, often causing markets to behave in ways that are misconstrued as evidence of irrationality, by Keynesians and other EMH critics. Uncertainty itself seems to be misconstrued as evidence of irrationality, when it in fact should be viewed simply as an inherent inefficiency in the market. (An example of true "irrationality" is to say that because markets aren't perfectly efficient, government should intervene. Despite their imperfections, markets are far more efficient and rational than government at processing information and valuing assets.)

Liquidity issues can be triggered by any number of events, such as a natural disaster or a market slide brought on by new information and the time delay during which the market is assimilating some new information. In the case in which new information triggers it, it goes like this: 1) New information becomes available that will lower the equilibrium price. 2) As the price falls into the target price range of new buyers, these buyers must first liquidate other assets and free up the cash. 3) However, while assimilating the new information, prospective buyers become more "conservative" because of the increased risk associated with the information itself and with the uncertainty. Buyers lower their bid price and the assets become temporarily less liquid. 4) Some asset holders in need of liquidity are compelled to sell. This need for liquidity may even be exacerbated by the falling prices and the impaired liquidity, pushing some sellers into a "motivated" selling mode which can easily be misconstrued as "irrational". 5) Motivated selling coupled with reluctant buying cause a slide until the markets have assmimilated the information, prospective buyers have reset their bid price, AND these willing buyers have converted other assets to cash sufficient to buy the surplus from the motivated sellers. All of this creates the appearance of "irrationality". Kelly J Bailey (talk) 23:34, 3 October 2009 (UTC)97.116.24.66 (talk) 23:32, 3 October 2009 (UTC)

My personal theory

I have a theory that all form of EMH are valid but they are proportionally relevant in regard to the totality of that information within the market, based on the weighted distribution among asset class for example Domestic Large-Cap Growth Style i.e. S&P 500 will demonstrate strong-form of EMH, but if I go into Emerging micro-cap value style - I would expect weak-form of EMH. I have been talking to my finance professors via email correspondence here is a Transcript After reading the transcript, I would like to hear any suggestion and comment that you might have. Paul.Paquette

Bubbles

Sorry if I'm wrong, but I'm pretty sure that market participants have to be RATIONAL, profit maximisers (Fama 1965 Random Walks in Stock Market Prices p76 second paragraph) therefore bubbles are not an example of an efficient market! it's actually the exact opposit (see also the efficient market theory in wikipedia: http://en.wikipedia.org/wiki/Efficient_market_theory where it says the exact opposit as what's written here). 203.217.87.5 00:07, 19 April 2006 (UTC)Emmanuel

Efficient Market theory text (to be merged)

This is the text from Efficient Market Theory which obviously should be merged in this article. Much of it is overlap, but please look to see where some of this can go!

Efficient market theory is a field of economics which seeks to explain the workings of capital markets such as the stock market. According to University of Chicago economist Eugene Fama, the price of a stock reflects a balanced rational assessment of its true underlying value (i.e., rational expectations); its price will have fully and accurately discounted (taken account of) all available information (news).

The theory assumes several things including (1) perfect information, (2) instantaneous receipt of news, and (3) a marketplace with many small participants (rather than one or more large ones with the power to influence prices). The theory also assumes that (4) news arises randomly in the future (otherwise the non-randomness would be analysed, forecast and incorporated within prices already). The theory predicts that the movements of stock prices will approximate stochastic processes, and that technical analysis and statistical forecasting will most likely be fruitless.

no, no, no, no, NO! Strong form efficiency requires perfect information. Other forms assume less perfect information --Thesurveyor 01:11, 3 July 2007 (UTC)

This efficient process of price determination can be contrasted with an inefficient market in which, according to the theory, the pre-conditions for efficient pricing (perfect information, many small market participants) have not been met and prices may be determined by factors such as insider trading, institutional buying power, misinformation, panic and stock market bubbles and other collective cognitive or emotional behavioral biases.

Absence of risk-free arbitrage opportunities

I believe the key requirement for an efficient market is the absence of risk-free arbitrage opportunities. See Richard A. Brearley, Stewart C. Myers, Principles of Corporate Finance. RDSeabrook 19:12, 19 June 2006 (UTC)

a comment by someone named John McGinley

A much adored theory in the 50's, the Efficient Market Theory (EMT), has been conclusively proved never to have existed by Profs. Andrew Lo (MIT) and Craig MacKinlay in "A Non-Random Walk Down Wall St." Their proof, currently available, published circa 1988, took about two years for academics to finally accept. I feel the EMT theory should not be promulgated on your site, except as a dinosaur. The Random Walk we will deal with next.

John McGinley,CMT, Past Director of the Market Market Technicans Assn.

I have met with and discussed this with Andrew at great length. A shame it is not as well known as the proven fact that is. EFM does not exist, and never has.

Your references to Malkin's book are surpflulous and irrelevant. The entire book, given the recent reseach, is not accurate, attestable, credible. Knowing what we know now, it never should have been printed.

I hope this will be published in place of the innacurate info.

John McGinley, CMT, past board member Market Techicians Assn.

a rejoinder -- how very intriguing. Lo and McKinley's work is, indeed, well regarded in academic circles. However, to use it as a total refutation of the EMH is... well... let's be kind and say "shortsighted". Even Fama has of late recognized certain shortcomings in the EMH. Nonetheless, we teach it because it helps us understand how the market works. No one hypothesis captures the entire market, but the EMH has certainly withstood the test of time. As an example, Sharpe's CAPM was "refuted" by the Roll Critique. Nonetheless, we still use the CAPM, we still teach it in nearly every Finance or Investments text, and the majority of investors still use CAPM or some variant to determine required rates of return. It's a very useful model, even if the theoretical underpinnings aren't as solid as once thought to be. --Thesurveyor 01:10, 3 July 2007 (UTC)

Rational and Rational Expectations

For this article, we need to draw a distinction between rationality and rational expectations. It correctly says people do not need to be rational (thinking based on reason, not emotion or habit, which leads to action that achieves goals) for the EMH to work. However, they do need rational expectations (updates their predictions with new information and are not systematically wrong). I will make these changes now. --David Youngberg 23:38, 12 August 2006 (UTC)

My internet clunked out right after I saved the above message, denying me from editing the page. It just came back and I changed the page as I said but I forgot to sign in again when I did. The edits by 68.100.77.213 are me. David Youngberg 03:38, 13 August 2006 (UTC)

A more rigorous definition

By saying that all that is needed for weak-form EMH to hold is that "investors' reactions be random and follow a normal distribution pattern" are we saying that impulses to the system are stochastic and the overall response function is ergodic (or weak-sense stationary, at least)? If so, the mathematical basis of this stuff could probably be enhanced. Just a thought. —The preceding unsigned comment was added by 200.122.159.125 (talk) 03:06, 28 December 2006 (UTC).

A Random Walk Thru This Article

A few random thoughts....

Gene's dissertation wasn't on the EMH, it was on the random walk theory. Gene didn't publish on the EMH until the May, 1970 issue of the Journal of Finance, although he had discussed some of the issues in an earlier (1968) IER paper.

The EMH does not... asserts that financial markets are "informationally efficient", or that prices on traded assets, e.g., stocks, bonds, or property, already reflect all known information and therefore are unbiased. Rather, as the article goes on to make clear, EMH puts forth several different sets of conditions, "strong form", "semi-strong-form", and "weak form" efficiency. The extent to which a pricing market follows one of these forms, (or none of them, for that matter) one can use prices to infer information. --Thesurveyor 01:03, 3 July 2007 (UTC)

EMH is a falsified hypothesis

Why is it the case that this isn't asserted to be false, and listed as pseudoscience? Although economics is hardly scientific, a scientific hypothesis has to be falsifiable. Given that EMH has been falsified over and over and over and over again, then it is a falsified hypothesis. So, it is false. To have it as a criterion for scientific consideration means that it can be useful in understanding how other explanations may diverge from a falsified hypothesis, i.e. they may explain stochastic processes where EMH fails to explain observed data. To propound EMH as a valid hypothesis, after falsification, is only allowable in pseudoscience. —Preceding unsigned comment added by 71.132.135.22 (talk) 22:39, 18 February 2008 (UTC)

Newton's law of gravitation has been falsified by Einstein, too. They are still considered to be scientific, though. A valid hypothesis needs to explain something that other hypotheses can not explain. It does not need to be right all the time. Quantum mechanics is the best tested hypothesis in physics. Still, it fails when it comes to very large energies (relativity, again). Which economic theory is better than the efficient market theory and in what respect? —Preceding unsigned comment added by 84.170.93.163 (talk) 21:20, 17 November 2008 (UTC)

Let us forget binary logic. Like many things, the EMH is a half true / half false hypothesis. Now the question is: what is the bigger half ? --Pgreenfinch (talk) 21:41, 17 November 2008 (UTC)

Let's not forget binary logic. What we should forget is Karl Popper's philosophy of science, which has been largely discredited. Falsifiability is no longer taken as defining science by any serious philosopher. What we should certainly take account of in this article is that EMH is a hypothesis, and many people disagree with it. The section on 'popular reception', as it now stands seems to assume that EMH is true, and discusses why the general public is too stupid to understand it. Alboran (talk) 21:39, 3 April 2009 (UTC)

Fractals

I think that the view of Mandelbrot that financial time series exhibit a multifractal pattern should be incorporated into the article. See this article: http://www.sciam.com/article.cfm?id=multifractals-explain-wall-street.

Another view on the mathematical pattern of randomness is that of Nassim Taleb. See this article: http://www.edge.org/3rd_culture/taleb04/taleb_indexx.html —Preceding unsigned comment added by Whisky brewer (talk • contribs) 13:15, 31 December 2008 (UTC)

Criticism and behavorial finance

It is clear that the first sentence of the second paragraph is incoherent - It appears like part of the sentence got deleted somewhere along the line, but I can't piece it together. Perhaps someone could fix this. Nwlaw63 (talk) 19:54, 8 January 2009 (UTC)

Criticism section needs better arguments

I really can only come at this from an approach as something of a mathematician but citing five investors who allegedly beat the market on a long-term basis isn't a very strong criticism. First of all the terms "beat" and "long-term" are pretty poorly defined. Second I would expect that any actual mathematical expression of probability (except perhaps where some variable is unbounded) would show that people consistently outperforming the market are simply unlikely not impossible.

Some of the psychological research is interesting but it somewhat strikes me as "criticism du jour" in that, again "short term" and "long term" aren't well defined and that suppose that attempting to take advantage of certain cognitive biases does allow you to make some money but it seems to leave out the possibility that a significant percentage of people could attempt this and negate its effect.

Similar things about bubbles. Again I would expect these to be "rare" not "impossible".

While the section itself needs work, there have been too many papers to mention that prove that EMH belongs in the same place as Flat Earth and the sun orbits the earth. Yes, the argument that a few people beat the indices is silly, as the law of large numbers of course predicts that, but there is no doubt among people who are willing to think on their own, rather than listen to dogma, that EMH is dead. Sposer (talk) 14:53, 27 January 2009 (UTC)

I'm not discounting the possibility that EMH has been falsified (Although I haven't done enough reading to find a formulation that is actually experimentally falsifiable let alone experimental evidence to that effect) if the argument that a few people beat the indices is bad then it is just as bad to keep those in the article as it is to keep the article neutral about EMH if it has been proven false. Considering that someone like yourself who is critical of the EMH finds said arguments as ludicrous as I do makes a good case to remove them. Even if not everyone (here) can agree on the state of the EMH. Also in the interest of Wikipedia being a high-quality source of information. I think it's a good idea to keep popular fallacies out. For example this kind of poor argument shows up online and in that new book by Cooper 'Origin of Financial Crises'. If there are really that many papers disproving the EMH then we are really doing people a disservice by not mentioning them and pulling relevant information out of them and into the article. —Preceding unsigned comment added by 205.211.168.53 (talk) 22:17, 27 January 2009 (UTC)

I've removed the silly paragraph identifying people that have beaten the market. Will look at adding other academic papers later. Sposer (talk) 22:27, 27 January 2009 (UTC)

I'm reading the 'non-random walk' papers now by Lo and the "Macs". Nothing mind blowing so far. I'm kind of excited to see what the arguments are. At the back of my mind I'm still bothered by the poor definition of terms in the EMH like "long-term" which make it hard to falsify. So far virtually all criticism I've read so far seems to mistake anecdotal evidence for counter-example. That is to say that most of the critics seem to think that the EMH is written like it's a logical absolute (therefore only needing a single counter-example to disprove) however from what I've read - even here in the Wiki sounds more like a probabilistic statement. Which of course would require a criticism that is also probabilistic. So far only three possible counter examples come to mind: i) Something like "Any formulation of the EMH requires event X to be bounded at odds R but empirical evidence shows that event X occurs much more frequently than R" ergo no reasonable formulation of EMH can be true. This seems like it's going to be hard since these are large datasets. The other possibility ii) would be to explaining a strategy where you can beat the market indefinitely even when everyone knows how to do so - which seems logically invalid. iii) Is coming up with some internal inconsistency which might be the best path to attempt a disproof. Also people don't seem to differentiate between a strategy and a result. For example if I was granted by the Almighty the ability to perfectly predict stock values, assuming I don't sell or otherwise disclose my picks then even though I am consistently and forever making money off the market I would state that this is still not a violation of most of the forms of the EMH since it is difficult for this information to become what "everyone knows". —Preceding unsigned comment added by 206.248.171.144 (talk) 05:25, 28 January 2009 (UTC)

To further my questions I offer the opinion of J. Farmer [2] a critic of the EMH who co-authored a paper with Lo (one of the authors of non-random) "...the fact that the EMH, by itself, is not a well posed and empirically refutable hypothesis" this is starting to parallel my opinion that it's ignorant to call the EMH falsified. —Preceding unsigned comment added by 206.248.171.144 (talk) 05:39, 28 January 2009 (UTC)

Unable to locate reference

I am unable to locate the Dreman paper referred to in the sentence, "According to Dreman, in a 1992 paper, low P/E stocks have greater returns. In this paper he also refuted the assertion by Ray Ball that these higher returns could be attributed to higher beta,[17] whose research had been accepted by efficient market theorists as explaining the anomaly[18]:151"

Can anyone?

Normxxx (talk) 02:00, 26 February 2009 (UTC)

EMH assumes random walk based on stable Paretian distribution

Fama paper "The behaviour of stock markets prices" (1965)says random walk based on stable Paretian distribution NOT normal distribution, so incorrect references on the page ...

Popular Reception

This section suffers from both awkward writing and a lot of unsourced opinions. I've tried to clean it up a little bit on both counts. Nwlaw63 (talk) 22:42, 8 May 2009 (UTC)

Awkwardness of the Historical Section

Although some improvements have been made, the article still seems to suffer from some awkward writing, and an awkward order of the sections. In the historical section, Firth's research is discussed in terms of being semi-strong-form efficient before that term is explained in the theoretical section below. Perhaps some shuffling of the sections is in order. And that awful sentence leading the last paragraph of the historical section has to go - I'll delete it soon if no one else objects. Nwlaw63 (talk) 17:53, 27 May 2009 (UTC)

Criticism and Recent Events

EMH has taken a severe beating from economists recently, with many of them blaming belief in efficient markets for the current financial crisis. You would never know this from reading the article - I have added a statement in the lede to reflect this. I have started to add corresponding material in the criticism section as well, which I will expand to appropriately reflect current sentiment. Nwlaw63 (talk) 17:39, 12 June 2009 (UTC)

Survivorship bias

Has anyone scrutinised the data given in the pretty scatter graph of the P/E ratio to see if it is influenced by survivorship bias? If you select a number of companies and go forward 10 or 20 years from year X, then many companies will fail, be taken over, or otherwise disapear. If however you select a group of companies and go back 10 or 20 years, then they will not have failed etc because they are the survivors - you are ignoring the failed companies. 78.146.3.82 (talk) 20:07, 3 September 2009 (UTC)

Criticism in the beginning

IMO you can't just put a criticism by a "renown financial journalist", that's not credible enough for the main section. It must be removed or changed to a criticism by an academic, and with less agitated wording.

Agree. This article seems backwards. The first section refers to a criticism by a journalist, the last section "Popular reception" refers to a criticism by an academic. We need to get the idea across that the EMH is a fundamental concept still used daily by finance academics and practictioners (almost none of whom believe all versions are 100% true). But we also need to report that there is academic criticism and enormous popular disbelief Expertofsome (talk) 23:19, 3 October 2009 (UTC)

Externalities

Once factored in, externalities render the hypothesis dead and done. 24.36.78.185 (talk) 03:06, 4 December 2009 (UTC)