[HN Gopher] The paradoxical efficient market hypothesis (2024)
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The paradoxical efficient market hypothesis (2024)
Author : tkhattra
Score : 80 points
Date : 2025-10-08 02:11 UTC (20 hours ago)
(HTM) web link (3quarksdaily.com)
(TXT) w3m dump (3quarksdaily.com)
| smitty1e wrote:
| For this paradox to function, information would have to be
| static, unless I'm missing something.
| tru3_power wrote:
| Also wouldn't all information have to be available to all
| participants? How does insider knowledge factor here (because
| it sure does in the market)
| chii wrote:
| those insiders could be choosing an action that affects the
| markets, or thru inaction, affect the markets.
|
| The current insider trading rules only prohibit actions, and
| does not prevent inaction.
|
| As an example, you could imagine that an insider were going
| to sell their portfolio of company issued shares, but because
| of insider info they have about a current project that would
| give rise to a price hike, they may choose to sell _later_
| (or not to sell at all). This means the liquidity of the
| market is now less, and thus, raises the price vs the
| counterfactual world where said insider _did_ sell. All
| without revealing any information about the actual insider
| project.
| smitty1e wrote:
| For a sufficiently large market, over time, one would
| expect the Central Limit Theorem to kick in and filter the
| noise.
|
| The "Efficient Market" can be seen as an Eternal Steady
| State, neglecting all transient signals.
| chii wrote:
| but doesnt the central limit theorem require each event
| to be i.i.d. ?
|
| I dont think the efficient market is a result of the
| central limit theorem, since each transaction affecting
| the market is not independent of each other.
| smitty1e wrote:
| Fair point. Thank you.
| GMoromisato wrote:
| This seems to be a case of a feedback loop creating emergent
| behavior.
|
| Let's say almost everyone believed in the Efficient Market
| Hypothesis (EMH). Then, trading would decrease significantly,
| since most people would think that stocks are already fairly
| priced. That means the few people who trade would move the market
| significantly, based on whatever idiosyncratic value-theories
| they had.
|
| But then the EMH believers would see wild moves in the market and
| stop believing in EMH. They would start trading more to gain
| profits.
|
| And as more traders participated, the market would behave more
| and more like the EMH were true. Eventually, the market would
| stabilize. Prices wouldn't swing so much. This would increase the
| number of EMH believers.
|
| It would be interesting to survey belief in EMH among traders. If
| my model is correct, the percentage of EMH believers should be
| roughly constant, or at least oscillate around some optimum
| value.
| JetSetWilly wrote:
| Sounds a bit like the Adaptive Markets Hypothesis. In it
| there's constant "evolution" between different trading
| strategies that become more or less efficient over time.
|
| So here, Phase 1 would be a market dominated by EMH believers
| who passively invest. In phase 2, speculative "noisy" traders
| start to exploit this landscape to profit. In phase 3 there's a
| crisis or period of high volatility. The old complacent EMH
| strategies suffer losses and become extinct. Then no doubt in
| phase 4 the market moves to some new equilibrium with new
| strategies dominant!
|
| So in this AMH theory what you describe is a natural process of
| evolution.
| Terr_ wrote:
| > since most people would think that stocks are already fairly
| priced
|
| Like the classic economist joke where they ignore a $100 bill
| on the ground: "It can't be real. If it were, somebody else
| would have already picked it up."
| wakawaka28 wrote:
| What you seem to be missing is that people don't solely derive
| value estimates based on the opinions of others. There are
| business fundamentals which can lead to one or more value
| estimates under different assumptions. If you don't do your own
| calculations, you may still read calculations from other people
| and reach a conclusion as to whether the true value of the
| stock is higher or lower than the market price.
|
| EMH is about the tendency of the market to be efficient over
| time. It is purely of academic interest to dream up
| hypothetical scenarios where everyone is equally rational and
| informed, etc. There are degrees of efficiency and information,
| and it's useful to talk about this to try to understand how
| real markets work and can be made to work better.
| Tazerenix wrote:
| The EMH is a _description_ of how the market behaves when a
| sufficiently large number of independent actors are looking for
| alpha. It is not a _prescription_ of how the market should
| behave.
|
| The conclusion is that with a sufficiently large number of actors
| in the market all seeking profits by trying to find misevaluation
| of stock prices, the excess profits of any individual actor will
| (assuming they all have access to the same information) converge
| to zero.
|
| Its less a paradox and more a matter of game theory. Every
| investment firm which gives up trying to look for alpha
| (believing it is fruitless) means the remaining firms have more
| opportunities to find stocks with available information not
| reflected in the price. There's no paradox here: each individual
| actor is incentivized to participate in order to not miss out on
| that potential for excess profits, and the net effect is the EMH.
| repsilat wrote:
| Yeah, I think the "paradox" is usually a problem for pundits
| and academics and not practitioners. Lots of people have
| experience finding and correcting market inefficiencies,
| usually getting paid for it.
| rcxdude wrote:
| Yeah, I feel like people have this idea that the EMH is
| 'economists think markets are perfectly efficient' when
| really it's 'under these idealised conditions a market should
| approach perfect efficiency' and any real market is obviously
| not going to be perfectly efficient, but ones that get closer
| to those conditions should be more efficient.
|
| (And looking at how traders work, it's all about finding a
| strategy that no-one else has found and executing on it. Once
| two competitors with similar resources know the strategy, it
| ceases to be particularly profitable, which to me seems to be
| pretty in line with the EMH)
| johnnienaked wrote:
| If the market is efficient then there is no risk adjusted
| alpha, which renders the search for it a waste of time and
| effort, which means no actor would rationally continue it,
| which means there is no mechanism for price discovery, which
| would render the market totally inefficient.
|
| This is the paradox.
|
| EMH is unfalsifiable at best and tautological at worst.
| throw0101a wrote:
| See also:
|
| > _The Grossman-Stiglitz Paradox is a paradox introduced by
| Sanford J. Grossman and Joseph Stiglitz in a joint publication in
| American Economic Review in 1980[1] that argues perfectly
| informationally efficient markets are an impossibility since, if
| prices perfectly reflected available information, there is no
| profit to gathering information, in which case there would be
| little reason to trade and markets would eventually collapse.[2]_
|
| * https://en.wikipedia.org/wiki/Grossman-Stiglitz_paradox
|
| So the more efficient markets are, the hard it will be to find
| "alpha" (returns), and so more people will stop trying. But as
| more people stop trying, markets will become more inefficient, in
| which case people can find alpha again, which encourages more
| participants.
| ggm wrote:
| Turnips and Carrots could be priced equally per tonne, and
| still be worth trading because although you might think all
| root vegetables are substitutable, it turns out you can't make
| carrot soup with Turnips.
|
| It's always worth remembering trade involves use values as
| well. We don't only trade for asymmetric profit, and there are
| things like hedging which include a yield where both can
| acknowledge future risk, and price accordingly.
|
| I'm probably ignorant of some magic economist reason why the
| words are fluid and don't mean what I think they mean: this
| always seems to be the case talking economics from the stuffed
| armchair.
|
| Another take on this is that we can agree to facts and disagree
| to consequences. Same information, different conclusions.
| imtringued wrote:
| This plays directly into fisher Black's "Noise"
| http://www.e-m-h.org/Blac86.pdf
| derf_ wrote:
| Anyone who has lived through a market correction (the tariff
| announcements in early April this year being a recent example,
| though there have been far worse) should be able to see that
| market prices do not always accurately reflect even the consensus
| view of value (which itself can be wrong). As people are forced
| to de-lever, everything goes down at once, often by very similar
| amounts, even though it cannot be possible that everything
| suddenly lost the same amount of value simultaneously.
|
| To quote Richard Bookstaber, "The principal reason for intraday
| price movement is the demand for liquidity... the role of the
| market is to provide immediacy for liquidity demanders. ...market
| crises... are the times when liquidity and immediacy matter most.
| ...the defining characteristic is that time is more important
| than price. ...diversification strategies fail. Assets that are
| uncorrelated suddenly become highly correlated, and all positions
| go down together. The reason for the lack of diversification is
| that in a high-energy market, all assets in fact _are_ the
| same.... What matters is who holds the assets. " (from A
| Framework for Understanding Market Crises, 1999)
|
| Was the market drop an accurate reflection of the value that
| would have been destroyed by those tariffs, discounted by the
| probability that they would have been enacted as drafted? Nobody
| knew then, and I maintain that nobody even knows now. That was
| not the calculation that was being made.
| AnthonyMouse wrote:
| > As people are forced to de-lever, everything goes down at
| once, often by very similar amounts, even though it cannot be
| possible that everything suddenly lost the same amount of value
| simultaneously.
|
| The price of something and the value of something were never
| expected to be the same. What's the value of food? If you have
| none you die, so the value is quite high, but the price is much
| lower than that because there are many competing suppliers.
|
| And the price of a large class like investment securities can
| easily change all at once if there is a large shift in supply
| or demand.
| nopassrecover wrote:
| > The price of something and the value of something were
| never expected to be the same
|
| While I agree with you (quite firmly: it's a great starting
| point to put on the table to challenge orthodoxy in this
| space), and think you're agreeing with the parent comment, it
| is a fundamental tenet of mainstream economics and the
| political arguments of neoliberal (aka current mainstream)
| policy that [price == (market averaged) value], or at the
| very least [price ~= value].
|
| Another interesting line of argument is to explore things
| that are valuable that don't typically get a price: for
| example household labour, or love and friendship (at least
| directly: I'm sure a Friedman acolyte would reduce all
| relationships to exchange and reframe gifts and acts of love
| as investments).
|
| As an aside for the parent comment: thanks for sharing this,
| it's one of the top category of comments/quotes I've seen on
| HN in being useful, insightful, and challenging of
| conventional understanding in a way that improves
| understanding and future prediction.
| addcommitpush wrote:
| Note that in orthodox microeconomic theory, price is equal
| to the marginal value of the last exchanged unit. To use
| the above example of food:
|
| > What's the value of food? If you have none you die, so
| the value is quit of high, but the price is much lower than
| that because there are many competing suppliers.
|
| The first calories of the day, the ones that prevent you
| from dying, have a very high subjective value - but you pay
| them at the value of the 3000th calorie of the day, the
| extra drop of ketchup on your fries, which has a very
| little value.
|
| And thus of course average value x volume is very different
| from (marginal value of last unit) x volume.
| dragonwriter wrote:
| > While I agree with you (quite firmly: it's a great
| starting point to put on the table to challenge orthodoxy
| in this space), and think you're agreeing with the parent
| comment, it is a fundamental tenet of mainstream economics
| and the political arguments of neoliberal (aka current
| mainstream) policy that [price == (market averaged) value],
| or at the very least [price ~= value].
|
| For mainstream economics, this is true in a very specific
| technical sense; all averages lose information, and the
| "market average" is a very particular form of average that
| doesn't behave the way most people think of an average
| behaving--particularly, it is not like a _mean_ , the
| normal "average" that people think of, that is sensitive to
| changes in any individual values, it is somewhat like a
| median in that it is insensitive to changes in existing
| values that do not cross the "average"; e.g., if you take
| an existing market for a commodity with a given clearing
| price, and reduce, by any amount, the value of the
| commodity to any proper subset of sellers who would sell at
| the current market clearing price, the market clearing
| price does not change. The assessment of value across the
| market has decreased, but the output of the particular
| averaging function performed by the market has not.
| energy123 wrote:
| Mainstream economists believe that value >= price. This is
| where economic surplus comes from. This is why trade is not
| zero sum, and it's why trade causes societies to get
| wealthier. Friendship and love fit into this framework just
| fine, as the price is $0, but the value is greater than $0.
| tennysont wrote:
| Put another way: price is determined by need _and_ supply
| (aka, demand curve meets supply curve).
|
| I would pay anything for air if I needed it, but I will
| gladly sell air in my yard for $1/m^3 because that air is
| worthless to me.
|
| Is air priceless or worthless?
|
| That is why price != value as most people think of it.
| teiferer wrote:
| Not disagreeing with you, but isn't that already obvious
| from the fact that economic activity happens in the first
| place?
|
| If you buy 5 apples from me for $5 then two things must be
| true: 1. The value that those 5 apples have to you
| _exceeds_ the value that $5 have to you, at least at this
| very moment. Otherwise you would hang on to your $5
| instead. 2. The value that those 5 apples have to me is
| _less than_ $5 have to me, otherwise I would hang on to the
| apples.
|
| The price of those 5 apples at this moment may be $5 but
| that doesn't reflect the value they have to neither me nor
| you. It's not the avereage either, necesarily. The only
| thing we know is that the value of them to you is higher
| and to me is lower.
| AnthonyMouse wrote:
| Not necessarily. You could have a transaction take place
| where the buyer and the seller both value what's being
| exchanged in exactly the same amount and then go through
| with the transaction anyway because they both find trades
| entertaining or have a cultural preference for doing
| business with each other or just both place zero value on
| transaction costs.
|
| That isn't common but that doesn't mean it could never
| happen.
| JackFr wrote:
| > they both find trades entertaining or have a cultural
| preference for doing business with each other
|
| That is value. It is any benefit they capture which they
| would not otherwise.
| kqr wrote:
| It seems like Bookstaber argues not that it's liquidity demand
| over information change, but that it is _both_. The tariff
| announcements are actually a great example, because it was
| triggered by new information, and diversification still kind of
| worked (at least some government bonds gained value during the
| drop in other assets classes).
|
| The main question, I suppose, is why correlations were so high
| after the tariff announcements:
|
| - In some cases, the high correlations are probably due to the
| markets being directly affected by the announcements: both
| commodities and equity are affected, and they got more
| correlated, which makes sense.
|
| - In some cases, the high correlations are probably due to
| liquidity demand rather than markets being directly affected by
| the announcements: we would not expect cryptocurrencies to be
| directly affected by US tariffs, but they ended up correlated
| with equity markets anyway. That's probably because people
| needed to sell off their cryptocurrency to cover equity losses.
|
| Thus in this case, it's again probably a bit of both.
|
| Great paper. Thanks for referencing.
| readthenotes1 wrote:
| "was triggered by new information,"
|
| Trump had been threatening tariffs for the campaign and
| mentioning them before. There wasn't that much new
| information that should have caused the plummet.
|
| Also I will point out that it's more like the avoidance of
| information that caused some of it Nvidia's stock plunged on
| an announcement that went something like:
|
| Sentence 1: we are putting tarrifs on Taiwan Sentence 2:
| except semiconductor related goods
|
| It as if the market participants read sentence 1 and very few
| of us read sentence 2.
|
| The EMH would assert that a casual observer like me wouldn't
| see the price gap between the time it took for people to read
| sentence 2. But it took several business days...
| mikeiz404 wrote:
| Paper: A Framework for Understanding Market Crises (1999)
|
| https://www.risknet.de/uploads/tx_bxelibrary/Bookstaber-Unde...
| mg wrote:
| the hypothesis maintains that stock prices reflect all
| relevant information about the stock
|
| This is a common description of the EMH. But every time I read
| it, I think: Does information really directly impact the price of
| a stock? How?
|
| What if it takes 12 months of hard thinking to draw the right
| conclusion from the information? Are there many investors who go
| to such lengths? Are they all thinking at the same speed? And if
| not, what does that tell us about the EMH?
|
| Google released DeepDream in 2015. My feeling is that with enough
| thinking, one could have predicted where image generation is
| going in the next decade and that language generation would go a
| similar route. And that this will lead to a high demand in
| Nvidia's GPUs. But that thinking would not be instantly. It would
| take months or years.
| truekonrads wrote:
| In systems thinking there's the concept of "stocks" or
| "buffers". Meaning that change of inputs into the systems first
| affect stocks/buffers before the outputs.
| AnthonyMouse wrote:
| > What if it takes 12 months of hard thinking to draw the right
| conclusion from the information? Are there many investors who
| go to such lengths?
|
| It's not required to be all of them. Suppose that it indeed
| isn't, but the ones who do that work for investment funds who
| control significant pools of money.
|
| Now the investors in two or three of those places do the
| research and conclude that some company is about to start doing
| well and their share price is currently $50 but is about to be
| $150. So they start buying it, and keep buying it until it gets
| up near $150. Which happens pretty quickly because they control
| enough money to use up all of the short-term liquidity at the
| lower prices and the majority of the shares are held by people
| who aren't even paying attention and therefore don't try to
| sell when the price starts going up. Once the price gets to
| that point they don't buy any more because it's no longer
| selling at a discount.
|
| Then the company actually starts doing well to the point that
| everyone can see it but the price hardly moves because it was
| already priced in.
| mg wrote:
| But do we see that happen?
|
| That would mean that the p/e-ratio of a company would rise
| sharply long before the profits set in. And that rise would
| be called "mysterious" by the general public. And then only
| when the profits set in, the p/e would come down.
|
| I can't see that in Nvidia for example:
|
| https://www.macrotrends.net/stocks/charts/NVDA/nvidia/pe-
| rat...
|
| The price roughly rose along the earnings. Even though the
| foundations for generative AI became clear in 2015.
| nearbuy wrote:
| The landmark paper, "Attention is all you need", that
| triggered the breakthrough that led to current transformer
| architecture LLMs, only came out in 2017. Without that
| breakthrough, they wouldn't exist. And even then, the early
| models produced gibberish. Better gibberish than older
| Markov chain text generators, but asking GPT-2 "What is
| three plus five?" would give some nonsense, non-sequitur
| answer, that might start with a (incorrect) number if you
| were lucky. At the time, everyone was wondering if scaling
| up the model size would improve intelligence or hit a wall.
| ChatGPT didn't release until 2022.
|
| And you'd need to know back in 2015 that Nvidia
| specifically would be the big winner from AI. They don't
| even manufacture their own chips. Intel also designs chips
| and GPUs, but if you bet on them in 2015, you'd have lost
| money between then and 2025.
| AnthonyMouse wrote:
| You're not likely to see that in huge companies because
| everybody is already paying attention to them and it's
| harder to know something someone else doesn't about the
| thing everybody already knows everything about. Also, then
| it's more likely to happen on a scale of 10 days than 10
| years.
|
| Where that really happens is with startups and younger
| companies. Some company is currently making negative
| dollars but a few people have figured out that they're
| likely to be big so their share price is up before their
| earnings are.
|
| And suppose you somehow actually knew what every major
| company's earnings would look like in every year from 2015
| to now. Do you invest in Nvidia in 2015? Or do you invest
| in Netflix in 2015 and Tesla in 2019 and so on and not
| bother with Nvidia until just before the hockey stick?
| throw0101a wrote:
| > _That would mean that the p /e-ratio of a company would
| rise sharply long before the profits set in. And that rise
| would be called "mysterious" by the general public. And
| then only when the profits set in, the p/e would come
| down._
|
| You have to look at the volumes involved: if there are tens
| of millions of shares of a particular stock moved everyday,
| a single event that involves 100,000 shares is going to be
| lost in the noise.
|
| There are always people who think they know better (if they
| didn't think so they wouldn't be trading), and they may
| make crazy-appearing trades. Lots of the people in _The Big
| Short_ were viewed as 'lunatics' ("You're betting against
| the housing market?") that turned out to be right. But also
| remember that there are people who think the world is flat.
|
| > _The price roughly rose along the earnings. Even though
| the foundations for generative AI became clear in 2015._
|
| It's also why you hear the talking heads on television say
| things like "...this has already been priced in.".
| chii wrote:
| you're wrong about the mechanism - it's not that the thinking
| is the cause of the efficiency. It's the large number of
| participants all doing their own brand of thinking, and that
| the _average_ of all of those approaches the "correct" price.
| It requires the large number of participants because for such
| an average to approach "correct", errors within each
| participant's guesses cancel each other out.
|
| And the immediacy comes from the large amount and speed of the
| transactions. It does not require that these participants sus
| out the correct value from information - they could've actually
| just guessed.
| Galanwe wrote:
| > What if it takes 12 months of hard thinking to draw the right
| conclusion from the information?
|
| I think the idea behind EMH is that this probability is priced
| in, at any point in time. It just so happens that longer term
| probabilities are discounted as more volatile, thus impacting
| less the present price.
| nearbuy wrote:
| Information that requires 12 months to figure out isn't
| information that's available now.
|
| Say you want to know the 400 trillionth digit of pi. We have
| all the information needed right now to know how to compute it.
| But you don't know what the actual digit is yet. The
| information isn't available and won't be until you set your
| supercomputer on it for some number of months. Having the
| information necessary to derive other information isn't the
| same as having the derived information.
|
| If there is some information about a future stock price that
| could theoretically be computed after months of work, that's
| still not information that currently exists, and therefore is
| not currently reflected in the price. If no investors go to the
| lengths to get that information, it'll continue to not affect
| the stock price. It's not violating EMH because it's not
| information that exists yet.
| mg wrote:
| That definition would mean that smarter investors, who can
| think faster and further ahead, get information faster. And
| therefore have information now that others do not.
|
| That seems to be directly the opposite of the common
| definition of the EMH, which emphasizes how the market
| _reacts_ to new information. And not how it _produces_
| information. For example in TFA:
|
| "the market rapidly responds to new information"
|
| Wikipedia starts the "Theoretical background" with an example
| on how information becomes widely available to all investors,
| not how one fast smart thinker generates it:
| Suppose that a piece of information about the value
| of a stock (say, about a future merger) is widely
| available to investors.
|
| https://en.wikipedia.org/wiki/Efficient-market_hypothesis
| nearbuy wrote:
| The smartest, fastest investors are the ones who make a
| profit by incorporating their information into the stock
| price in the EMH. The stock price can't move on its own.
| Under the EMH, someone has to be the first to trade stock
| based on information so that the stock price reflects it.
| When they say "the market rapidly responds to new
| information", that means investors with the new information
| are buying or selling accordingly. It's not opposite at
| all.
|
| How the information gets produced is irrelevant to the EMH.
| Whether it's obvious or takes hard thinking, either way,
| once investors obtain the information, they will trade
| based on it, and that will move the stock price.
| johnnienaked wrote:
| >That definition would mean that smarter investors, who can
| think faster and further ahead, get information faster. And
| therefore have information now that others do not.
|
| And that is trivially true
| throw0101a wrote:
| > _What if it takes 12 months of hard thinking to draw the
| right conclusion from the information? Are there many investors
| who go to such lengths? Are they all thinking at the same
| speed? And if not, what does that tell us about the EMH?_
|
| To paraphrase William Gibson: the information may be available,
| but it is not evenly distributed.
|
| It's why (e.g.) hedge funds use satellites to get information
| on company activities:
|
| * https://newsroom.haas.berkeley.edu/how-hedge-funds-use-
| satel...
|
| * https://internationalbanker.com/brokerage/how-satellite-
| imag...
|
| It's takes resources (time, money, etc) to gain an advantage,
| and it's only do it because they think some extra bits of
| information will allow them to know more than The Market in
| general / their counterparties to get a better conditions on a
| trade or options.
|
| Why do you think insider trading became illegal: some folks
| have that information before others simply because of their
| job/position. There was a case of someone knowing something
| early, because information can only travel as fast of the speed
| of light, which some "beat":
|
| > _Last Wednesday, the Federal Reserve announced it would not
| be tapering its bond buying program at 2 p.m. ET. The news
| takes seven milliseconds -- about the speed of light -- to
| reach Chicago. But before the seven milliseconds was up, a few
| huge orders based on the Fed 's decision were placed on Chicago
| exchanges._
|
| *
| https://www.npr.org/sections/alltechconsidered/2013/09/24/22...
|
| * https://www.motherjones.com/kevin-drum/2013/11/final-
| frontie...
|
| EMH is saying people that if people think they can make money,
| they will spend the resources to get an information edge to
| accurate price what a commodity is 'worth', either higher or
| lower. If you better know what it 'should' be, then you can
| devise a trading strategy (buy/sell/short/long) to get one over
| your counterparty.
| rich_sasha wrote:
| I think what is unquestionable is that statistically, given
| available information, it is hard to make money against other
| market participants.
|
| It _is_ a form of informational efficiency, but it does not
| necessarily follow that prices are even statistically correct.
| The market can be irrational for longer than you can remain
| solvent.
| saghm wrote:
| I forget where I first heard it, but there's a joke about two
| economists walking down the street. One of them notices a $20
| bill on the ground and points it out out, saying "Look, it's $20
| just lying there on the sidewalk!" The other shakes his head and
| says "No, that can't be true; if it were, someone else would have
| picked it up already"
| verbify wrote:
| This joke was in the article?
| scubbo wrote:
| Reading the article would have been inefficient.
| program_whiz wrote:
| HN equivalent: someone sees a link to an article and says
| "why would I read it, when all relevant information has
| already been incorporated into the comments?" Its the
| "efficient comments" hypothesis, all information relevant to
| a rational HN user about the article is already in the
| comments.
| t_serpico wrote:
| My practical interpretation of the EMH is more that easily
| accessible, public information is already priced in. But non-
| obvious insights may not be simply because the volume of people
| trading on that information will be smaller.
| OutOfHere wrote:
| EMH is nonsense that is repeated routinely to scare people from
| trading the market.
| Nevermark wrote:
| Information characterizing a company's value isn't the same thing
| as information indicating a company's value. There can be a lot
| of analysis and model building in between. And different models
| can behave very differently, even if their prediction strength is
| similar.
|
| Information publicly available doesn't mean anyone can process it
| all. Every actor is operating off a different subset of
| information.
|
| Lots of intentionally low information investors (inhabitants of
| indexed funds) demand stock or supply stock, pushing prices in
| directions unrelated to value changes, due to index list changes
| and rebalancing events.
|
| Investors, of all magnitudes of wealth, have unending personal or
| private idiosyncratic reasons for the timing of many investments
| or sales, besides individual asset return optimization.
|
| The value of a stock rises and falls as its absolute expected
| return rises and falls relative to the changing returns of the
| rest of the entire market of investment vehicles. Everything
| impacts everything.
|
| All these shifts happen over varying time frames.
|
| Almost all relevant market facts are time varying, often with
| turbulence and ambiguity.
|
| The fast moving investors most influential in setting prices,
| must model the whole market's 2nd order and even 3rd order
| reactions (by similar actors) due to feedback effects and
| dynamics.
|
| Sudden market wide changes trigger waves of low analysis buying
| and selling. Compounded by the higher order risk this creates to
| leverage, annuity responsibikities, hedging, and many other
| amplifiers of behavior.
|
| The efficient market hypothesis is an interesting and
| enlightening thought experiment. A reduced dimension toy/sim
| market.
|
| Not a credible model.
|
| Not even if every single participant was frantically and
| relentlessly re-valuing and re-balancing at the margins to a
| firehose of comprehensive market information.
| janalsncm wrote:
| Does the EMH state that prices will reflect on the price of a
| stock instantly? If not, I don't think there's a paradox. EMH
| would just mean it will eventually converge? I guess that makes
| it pretty toothless in practice then.
|
| I feel like the stock market is pretty divorced from fundamentals
| at this point i.e. speculation makes it more like a Keynesian
| beauty contest (picking stocks you think other people will think
| are valuable).
|
| https://en.m.wikipedia.org/wiki/Keynesian_beauty_contest
| marcus_holmes wrote:
| This is the truth. What drives the price up or down is
| speculation about whether the price will go up or down. There
| is only a very loose connection with actual company
| performance.
| vintermann wrote:
| Some institutional designs are more prone to Keynesian beauty
| contests than others.
|
| It's instructive to compare "Crowdfunding" which took off with
| Kickstarter ~15 years ago, with "Equity Crowdfunding", which
| gets tried again and again, and has not a single success story
| to its name.
|
| Kickstarter was made to fund artistic ventures, and for the
| first years, they were strict about only allowing that on their
| site. The idea was to reduce risk for e.g. people trying to
| bring their favorite band to the area for a concert.
|
| On old Kickstarter, you only pledged to a project if YOU want
| the product/outcome for its own sake.
|
| However, in "equity crowdfunding", where backers are tempted
| with a share in the profits of a venture, you should, if you
| are smart, try to ignore what YOU want. Your own wants are a
| source of error here: as a fan of the band, you're likely to
| overestimate its appeal. You should play the Keynesian beauty
| contest and try to guess what others want.
|
| Kickstarter understood the difference very well. In the early
| years, they banned such things as "reseller's tiers". Some
| people would support e.g. a boardgame with pledging for five
| copies of the game, betting on its success and hoping to resell
| four of them. That brings the KBC factor in again, and
| Kickstarter thought that it would eventually lead to the site
| being flooded with the things everyone thought everyone else
| wanted, rather than the things they actually wanted.
|
| There's a whole scam industry dedicated to exploiting the gap
| between what you want and what for its own sake and what you
| want because you think others want it: MLMs. MLM victims get
| tricked into a loop where they on one hand convince themselves
| that the product is great because they hope to sell it, and on
| the other convince themselves that the product will sell
| because it's great.
| throw0101a wrote:
| > _I feel like the stock market is pretty divorced from
| fundamentals at this point i.e. speculation makes it more like
| a Keynesian beauty contest (picking stocks you think other
| people will think are valuable)._
|
| Momentum investing is a thing:
|
| * https://www.investopedia.com/terms/m/momentum.asp
|
| * https://en.wikipedia.org/wiki/Momentum_investing
|
| A number of people make / made money when The Market became
| "divorced from fundamentals": see _The Big Short_.
|
| * https://en.wikipedia.org/wiki/The_Big_Short_(film)
|
| Just remember: "The market remain irrational longer than you
| can remain solvent." -- Keynes,
| https://www.goodreads.com/quotes/603621
| whatever1 wrote:
| Sir this is just a casino. Stocks have nothing to do with the
| businesses right after they are issued. A business can opt to
| just never issue dividends (Hi Amazon). So the stock itself has 0
| actual value. It does not generate cash. (Ok if the company goes
| belly up you will get a percentage of the carcass)
|
| But we can all gamble on what it is worth!
|
| So stockholders are like roulette pill holders. Everyone just
| bets on where the pill will fall. Few are luckier than others.
| Some smarter know whether the roullete is rigged and have better
| chances.
| tempestn wrote:
| A company could decide to never pay a dividend, yes. But that
| doesn't mean the stock is worthless; you need to take the
| thought process further. Who ultimately controls a company? The
| shareholders. So, imagine a scenario where a company is
| profitable and seemingly valuable, but for some reason the
| share price is not increasing, so the shareholders are not
| seeing their wealth increase. In that scenario they would
| probably either pay a dividend or, more likely, take advantage
| of the profitability and low stock price to buy back stock,
| driving up its value.
|
| Either way, the owners of a successful company are going to
| want to profit from it, which will _make_ the shares valuable.
| Of course, investors know this, and so the share price tends to
| track current value of expected future earnings even without
| the company taking direct action to distribute profits.
| mullingitover wrote:
| > Who ultimately controls a company? The shareholders.
|
| _Some subset of_ shareholders. For example: Meta Inc. and
| their Class A vs B shares, GOOGL vs GOOG, etc.
| whatever1 wrote:
| Also not clear what their voting power is as at any point
| the company can just issue infinite more shares.
| tempestn wrote:
| The existing controlling shareholders would need to
| support the issuing of new shares. They would only choose
| to dilute their own holdings if it were advantageous to
| do so.
| tempestn wrote:
| Sure, but whichever shareholders control the company, they
| ultimately want to profit from that ownership, right? So if
| the stock price isn't reflecting the true value of the
| underlying company, they're going to do something about it.
|
| I suppose there are edge cases where they will instead
| attempt to profit by convincing the board to pay the CEO a
| trillion dollars, but even that kind of thing probably only
| flies if the stock price is also going up. (I wouldn't have
| thought to include that exception at all some years ago,
| but at least one salient example has proven this possible,
| if not likely.) So I could see a case for not trusting the
| valuation of companies that behave in that particular
| manner. Where the CEO is effectively the controlling
| shareholder, especially if they have shown a willingness
| and ability to inflate their own compensation.
| mullingitover wrote:
| It's a Keynesian Beauty Contest:
|
| > A Keynesian beauty contest is a metaphorical beauty contest
| in which judges are rewarded for selecting the most popular
| faces among all judges, rather than those they may personally
| find the most attractive.
|
| This explains why informed investors know TSLA is worthless,
| but they also know that the retail market as a whole thinks
| it's as precious as unicorn tears, so it is priced accordingly.
| whatever1 wrote:
| So the market actually predicts the gambling strategies of
| the players.
|
| For example people who kiss their dice will likely put money
| on red.
| notmyjob wrote:
| Nancy Palosi.
| flave wrote:
| > if a sufficiently large majority of investors believe the
| hypothesis, they naturally would assume that new information
| about a stock would very quickly be reflected in its price. They
| would conclude that since relevant news almost immediately moves
| the price up or down, and since new developments can't be
| predicted, neither can price increases or decreases
|
| This is an oversimplification of how professional investing
| works.
|
| The vast majority of the dollar value of markets isn't governed
| by immediate profit seeking behaviour - it's people trying to
| manage money in the context of a real business. Pension fund
| money is the largest "pot" in the markets at any one time.
|
| Pensions funds aren't incentivised to maximise returns in any
| particular quarter/year. Instead, they're looking to manage risk
| and ensure consistent returns in the very long term.
|
| Therefore, the "value" they place on various assets is different
| to what a trend fund or retail investor is thinking about. The
| price at which they would buy/sell is different.
|
| The market value might "reflect" that information but it could
| easily create a situation in which short-term, strictly returns-
| motivated investors might value an asset much more than pension
| funds or vice versa. That creates opportunity for both to do a
| non-zero-sum trade and both "make money".
|
| I've seen it elsewhere in this thread but it's simply not the
| case that the "markets are a casino _". The vast dollar value of
| the market is about sharing risk and providing liquidity.
|
| The global bond market are at least 1.5 times the size of the
| equities market(s).
|
| _yes some markets are basically a casino but they're tiny in
| comparison.
| Galanwe wrote:
| > The vast dollar value of the market is about sharing risk and
| providing liquidity.
|
| This, very well summarized.
|
| I would nuance (but not disagree with) your comments on pension
| funds though. The thing is PF do not invest themselves, they
| usually are, or delegate to, funds of funds, which in turn
| decide on allocation based on the desired risk profile. It
| could very well happen that the total allocation is the sum of
| a multitude of individually short term investments, as long as
| these are diversified enough. I would concede that in practice
| that is not really feasible though.
|
| These risks profiles are numerous, diverse, and ultimately
| idiosyncratic. People often forget or don't know about all
| these risk constraints, because they work in a fund that is
| bound to a specific risk mandate.
|
| For instance, depending on how your investment vehicule is
| structured (the regulatory enveloppe through which you sell
| your fund, which ultimately determines to who you can sell, how
| you can advertise, how profits are taxed, etc), you can have
| liquidity constraints (e.g. clients should be able to redempt
| daily, weekly, ...) risk parity constraints (e.g. per asset
| class vol budgets, to be respected daily, weekly, etc),
| exposure budgets (e.g. country, sector, beta, ...),
| counterparty risk (e.g. minimum number of managers to allocate
| to, or clearing houses, or custodians), idiosyncratic risks
| (e.g. an insurance company will need to be neutral against
| natural disasters, healthcare exposure, etc), ESG, etc
| bjourne wrote:
| But maximizing long term returns means consistently maximizing
| short term returns. In fact, the larger the capital the larger
| risk you can take since you can survive longer streaks of bad
| luck as long as your bets have positive expected value.
| rhubarbtree wrote:
| The EMH is obviously bs, as anyone with an ounce of common sense
| can observe from today's market. To appeal to authority, buffet
| and monger and graham point out how insane Mr Market is, and
| they've done pretty well by exploiting its inefficiency.
|
| Market prices are derived from supply and demand. A heavy
| determinant of demand is income equality. Another is interest
| rates. These are nothing to do with, in general, a particular
| stock.
|
| It's so obviously false to anyone trading or even watching stocks
| that serious discussion by academics just adds weight to the
| accusation that they don't know what they're talking about. We
| need a new, more serious, science of economics.
| tempestn wrote:
| All models are flawed; some are useful. I would argue the EMH
| is an imperfect but useful model of market behaviour.
| rhubarbtree wrote:
| You make a good point and I'm open to changing my mind.
|
| How do you think it's useful? Can it be used to make
| predictions about the future, for example?
| tempestn wrote:
| Aggregate predictions, yes. For example, the long-term,
| risk-adjusted expected return of all liquid securities
| should be the same if we believe EMH. Therefore by holding
| a diversified sample of securities in a market, your
| expected return should be the same as that of the market as
| a whole (though actual return won't be). Any _expected_
| difference would theoretically be due to a difference in
| risk.
|
| Now, it may be that the risk is one that other people care
| about but you don't. Some investors might be more sensitive
| to short-term volatility than others, for example. But a
| weak EMH can at least give a framework for thinking about
| these kinds of decisions. (Like whether to value tilt, for
| example. Or whether to invest in active or passive funds.)
|
| It also gives you a framework to think about in which cases
| it is more or less likely to hold. Small, illiquid markets
| are the least likely to be efficient, in my opinion and
| experience. My only actively managed investment is in such
| a market.
| daft_pink wrote:
| The efficient market hypothesis is a useful framework to
| understand complicated dynamic markets, but like almost all
| economic theories it isn't like a law of physics that explains
| reality 100%, but is a partial abstraction that explains key
| patterns of human behavior and information flow within markets.
|
| You can think of it like a form of compression: it condenses an
| incredibly complex, chaotic system into something we can reason
| about. That simplification makes it powerful and insightful, but
| it also means that a lot of nuance and unpredictability are lost
| in the process. In contrast, a physical law can be calculated
| precisely and consistently, while market behavior is always
| shaped by human psychology, uncertainty, and imperfect
| information.
| johnnienaked wrote:
| Any hypothesis based on false assumptions is a priori false, and
| the EMH is filled with false assumptions.
| randomtoast wrote:
| I have just written an post on technical analysis that presents a
| balanced perspective on the Efficient Market Hypothesis, the
| Random Walk Hypothesis, and their relationship to practical
| applications. I explore how retail traders identify patterns, how
| these patterns may be exploited in high-frequency trading, and
| how machine learning contributes to detecting and leveraging such
| patterns. In case someone is interested:
| https://beuke.org/technical-analysis/
| water9 wrote:
| It makes no sense because people do not acquire information at
| the exact same time, nor do they act on it with the same amount
| of force, i.e., capital.
|
| It's the same stupid people who say the market is a random walk.
| Oh yeah, if it was a random walk, then why do earnings reports
| even matter? Companies could just lose and gain whatever they
| want, and stocks would just fluctuate randomly.
|
| Here's the truth. It's called Rice's theory of opportunity. It
| says that there is a golden window on the order of a few weeks to
| a few months where the signal-to-noise ratio has the least
| attenuation. This is because it avoids the initial transitory
| periods, the real-time gap between the knowledge existing and the
| knowledge spreading to people with enough resources to make a
| difference.
| tim333 wrote:
| I think the valuations of dogecoin and fartcoin don't fit well
| with the efficient market hypothesis. They both have no assets
| and no profits but fartcoin is valued at $668 million and
| dogecoin at $39 billion. Surely in a rational market fartcoin
| should be valued at more as it has a funnier name?
|
| Slightly more seriously his assertion:
|
| >Alternatively stated, the Efficient Market Hypothesis is true if
| [...] a sufficiently large majority of investors believes it to
| be false.
|
| is flawed. They could believe it false but still make a mess of
| the valuations. Which can cause real world problems if
| profesional investors put your pension money into webvan or other
| bubble stocks and then there is a cash shortage after the dot com
| bubble burst. Of course they are wiser now and won't make such
| errors with AI.
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