The market (in any good) is an information processing system which tries to collate a colossal number of variables down to a single one: price. It has the same limitations as other information processing systems, as well as things you may be familiar with from control theory like frequency response.
If prices encode information, then we are talking about a one-way encoding. You can’t turn that price back into a description of the whole vast supply chain behind it. That gives us another problem: prices can’t tell us whether a price is low for good reasons (efficient processes, technological innovation, economies of scale perhaps) or bad reasons (pollution externalities not included, use of forced labor, low quality ingredients, corners cut). Understanding these factors (“quality”) becomes a complex ordeal and the price doesn’t help.
It seems like we have an economy which is highly optimized at reducing price, but extremely primitive at making “quality” transparent enough that price can be properly assessed.
A case in point being Amazon marketplace where you can find very low priced products from completely opaque brands with almost zero signal on quality.
If the buyer cannot estimate the quality of the product before buying, the sellers will reduce quality or be forced to by competition. Buyers lose trust and the market can collapse.
The Akerloff Market for Lemons paper is really important. It explains so many things, like why people very rarely pay upfront for mobile games or online articles.
Yet people buyer newspaper without having read them…
The reason why people don't pay for online stuff is mostly because we're used to get free stuff online + the fact that online payment remains cumbersome (even moreso since the businesses have all incentives to pish you to a regular payment model instead of a one-shot one). It has nothing to do with information asymmetry.
And that a paper that reads like a parables like this was deemed Nobel-prize worthy tells us more about economics as an academic field than about the paper itself.
The problem there is that the owner of a car that’s good as far as they know (but not a given as a major repair of an older car could be just around the corner) may sell anyway so they can buy a new car even if they think they’re not getting a good deal. But certainly of cars that know they have major not easily detectable problems will be much quicker to sell or trade in. (I know.)
Hence the obsession with customer reviews. In the absence of an objective measure of quality, the easiest to implement is a star rating of "what everyone else thinks about this product".
Such review systems are trivially gamed, with exceedingly high incentives to do so.
One of the underappreciated benefits of an established retailier with limited suppliers and a centralised buying operation, as with traditional brick-and-mortar establishments (Harrods, Costco, Macy's, etc.) is that those establishments can set their own minimum standards and select merchandise which is highly likely to provide high value to the end customer. The notion that "choice is good" falls flat in the reality that uninformed choice over a range of intentionally insufficient products is not good, and is in fact a form of gambling with low payoffs.
Some retailers target high-end products (e.g., Harrods), some mid- or low-market (e.g., Costco). But by restricting upstream vendors, tracking satisfaction, and having their own testing and development of products or offerings, as well as return/warrantee programmes, they can assure a reasonable rate of satisfaction.
I'm also finding retailers who sell manifest crap (o hai any Samsung home appliances) can be eliminated from my own list of acceptable outlets for future purchases.
Oh sure, absolutely, but note I said "easiest to implement". And there's that cost measure again, as if it's the only KPI. How do we measure the quality of the "quality" system? :)
What elements of the quality system's quality would you think need assessing?
(I think your question's a valid one, and a quite good one ... a high-quality question, if you will. I also Have Thoughts, but would prefer to see you expand your question before polluting the idea space with my own biases and opinions. Though if I may steer the conversation somewhat: audits. Of what and how would be informed to your response to my first question though.)
My thoughts on assessment of a rating system leans strongly on audit methodologies.
It also starts with what the goals of a rating system are, and how it might be subverted or attacked.
I see four key principles or assumptions:
1. The reported ratings for overall product performance should correspond with some reasonable informed-experts' ratings.
2. Issues with product support (returns, refunds, repairs, replacements, etc.) should correspond with identifiable events.
3. Solicitation of ratings, false positive ratings, or false negative ratings as forms of harassment or industrial subversion are all obvious (and extant) forms of abuse, as would be the ratings platform itself predicating positive reviews on, say, advertising purchases by the reviewed site, as has been alleged in numerous cases.
4. Systematic abuse will tend to be orchestrated by a given entity, and should exhibit some form of behavioural or networked anomalies.
For key products (high volume, high-price, and/or both), independent assessments should be performed on at least some sample of products and conformity with assessed ratings shown. Where expert opinions can be reasonably attained, they should generally take priority over crowdsourced reivews, especially where specific expertise and tangible distinction in results exists. This is guided by both the notion that you'd rather have a skilled pilot than a democratic representation of passengers flying an aeroplane (a notion dating back to Plato, though he somewhat unambitiously used the example of a ship at sea), and awareness that in some cases there isn't much consistency even amongst experts, as with wine tastings and ratings. Third parties (e.g., Consumers' Union, Underwriters Laboratories) might also be compensated for unbiased expert assessments.
Individual raters with high volumes, anomalous ratings, or patterns of coordination with other raters (e.g., similar ratings on the same products) should be flagged for review, and potentially voided from the system.
Any indications of suppliers soliciting ratings, providing kickbacks or rebates, or otherwise inducing positive ratings should be addressed severely. I'd be in favour of a quick and long-term minimum-rating consequence. This of course raises the risk of suppliers "joe-jobbing" competitors' offerings to create the appearance of manipulation (by the target). That activity should result in an even harsher consequence.
The overall rating system and activity should be constantly monitored for anomolous patterns. Highly-active individual accounts are probably the easiest to detect. Large groups of low-activity accounts with similar activity are probably the hardest to detect, but would be another key issue. Audits of such behaviours should be a constant part of a system, and the subject of regular transparency reports.
Prices are a reduction of information in that since decisions that lead to price being set are past that information gets reduced.
Or to put it another way for an investor speculator they have to go to the chain that goes into producing that product to find the signals to use to short or buy a stock...not the price of the good itself..
You were making sense for a bit, then kind of went off the rails?
For instance, forced labor, pollution, etc. are factored into price. Or more specifically, the customers willingness to care about these things is factored into the price, on the buy side. And someone’s willingness and ability to do them (or hide them) is priced on the sell side.
Same with the customers willingness to gamble on quality (aka random no name branding), and a sellers willingness to deal with legal and reputational blowback.
People just don’t want to say it.
At the end of the day, as long as no one is going to shame them or punish them, most people will happily fund super polluting slave labor and gamble on quality for a cheap price.
Hell, as has been made clear over and over again, people will happily risk serious legal consequences and even murder people to supply/consume illegal goods that get them high, at a price. And that price is a lot lower than most people want to think about.
And this is where the EMH bears actual fruit - because the ultimate test is people’s willingness to part with their cash for a good. And both sides of the transaction are always trying to figure out ways to shift the line where they both meet in their favor.
It’s not about what they say, what they profess to believe, what is acceptable to admit, what is legal (per-se), etc. unless it actually matters.
Which is rarely as often as we’d all like to believe.
> For instance, forced labor, pollution, etc. are factored into price. Or more specifically, the customers willingness to care about these things is factored into the price, on the buy side. And someone’s willingness and ability to do them is priced on the sell side.
I don’t agree with this. Pollution primarily affects people who cannot afford to pay to not affected by pollution. The people who buy the most polluting products are not the people who are directly exposed to the most pollution. This isn’t as simple as “oh people just don’t feel bad enough to not buy cheap things”, the people who cannot afford to avoid the consequences of societally bad decisions are suffering way beyond their consumption! The poor live most exposed to effects of climate change (fires, floods, etc) because they cannot afford to avoid it, not because they somehow calculated that they don’t feel bad enough about it. The wealthy are not forced to have their house flooded in accordance to the number of cars they own, for example.
Agree more with you than GP. Revealed preference is a thing, virtue signalling and performative behaviour is rampant.
However, you can have a situation in a hypothetical economy where the VAST majority cares deeply about an issue and actually put the wallet where their mouth is. But the aggregate spending is different simply due to an enormous inequality in wealth. The integral of "revealed preference" across the population is not the same as a popular vote after all.
I guess some people would argue this is the case in western economies, that we "have no choice" due to powers at be, but I don't agree with this view. But it's conceivable that in some economies this is, or at least could be, the case.
Though, politics is power, and power is about money. Or is that sex? I forget.
Power definitely does impact markets, as it applies counter pressures on what matters or not, sometimes to the point of making it impossible* for a trade to actually occur. But always shifting what actually matters or not in some direction, and hence influencing prices.
Power unexercised is power that de-facto does not exist in the moment, eh?
So if the voters aren’t making something illegal (and ensuring enforcement) they aren’t exercising their power to influence that market, and hence that power does not yet exist. And so typically prices will merely reflect the risk premium of the potential. Not have it as fact.
And if the rich folk are transacting in these markets, and are using their power to hide and/or obfuscate that they are doing so, to avoid any public influence, that is power that definitely does exist right now..
And markets will reflect that, on the balance, or a trade won’t occur. When trades do occur, EMH gradually forces things towards efficiency. And the more players there are, and the more transactions occur, the more efficiency is inevitable. Barring things like monopolies, regulatory action, etc.
* though as the war on drugs (and the persistence of smuggling from antiquity through to the modern day) makes quite apparent, it is actually very difficult to stop all trade when there is a large market ‘potential’ that exists. Trade ‘finds a way’.
We will fund super polluting slave labor if the difference to the manufacturers is $1.25 vs $1.65 per unit in costs, but the manufacturers charge us $5 for the unethical unit and $20 for the ethical unit.
That's not to say we wouldn't spend $5.40 for entirely ethical production; We are not granted that choice. In a wildly unregulated market with little oversight, establishing the chain to demonstrate ethical viability is expensive, and only people who have a lot of income and spare time can afford to even be worried about this.
Right now, ethical production in many areas of world trade is dominated by a fringe marketting strategy to price-segregate customers, because nobody has even tried to regulate a better outcome.
Expecting people to spend many hours studying every single thing they consume for signs of malfeasance, especially when most of the data they would require is a trade secret or things which manufacturers are actively incentivized to lie about, is crazy. This information black hole provides a second limit to effective pricing.
I would add there is also a prisoners dilemma in any attempt to regulate to ‘good’ labor practices/rates in the global economy.
There are, for many clear domestic socio-political reasons (including highly embedded religious and idealogical ones), many countries which are never going to be effectively limited in their untrained labor force, or that have the ability/interest to enforce good labor practices.
And there are too many ‘buying’ nations to effectively enforce a Monopsony either.
The higher priced goods are going to move slower. The $20 price tag reflects the higher quality packaging (to reinforce the message that THIS is better quality) and targeting of higher spending customers, the higher price to the retailer, and the amount of time it has to sit on the shelf. Turnover is king as all retailers and manufacturers are sensitive to holding products. Warehousing has a steep cost.
* European double-pane sash windows: Effectively banned by various regulations
* American double-pane sash windows on hardware store shelf: $100
* European triple-pane tilt turn windows, on hardware store shelf: $200
* American triple-pane tilt turn windows, 'call for quote': $900
...
* No Salt Added Snacks in the health food section for 10% of people: $4
* Lots of Salt Added Snacks in the main section for 30% of people: $2
* The 60% of people who would prefer a moderate amount of salt for $2: Not a part of the Nash Equilibrium
There are all sorts of areas where the market offers suboptimal choices because consumer pricing, availability, product segmentation, and market segmentation is a game that is somewhat orthogonal to the range of consumers' ideal outcomes. Sometimes, regulation significantly improves those outcomes in a way that prices cannot. Banning slave labor is one example where it would be a significant benefit for a trivial cost, but the market absolutely isn't structured to pay that cost using higher prices.
Externalities not paid by consumer or manufacturer is one category of those benefits to examine, but there are many more.
> SSRN provides 1,453,207 preprints and research papers from 1,847,303 researchers in over 65 disciplines.
It's basically like Arxiv, but focused on different fields. The articles may be preprints of peer reviewed articles published in leading journals, or they may be mad ravings uploaded by a crank, or anything in between. Also see wikipedia's article on SSRN[1].
From SSRN's page on Algorithmic Finance[2], the supposed journal (reachable by following the link under the article title):
> The journal archives all papers on SSRN
Note that the journal managing editor and contact is the author of the paper, the contact info appears to be his personal contact info, and all links on the page are dead.
That’s a good signal. The moment a paper gets peer review at a place like NeurIPS, I know that the chances of the experiment section not being lies goes to zero.
The way "efficient markets" were taught in my econ classes was similar to the idea of a "limit" in calculus. A market can never reach efficiency but it can approach at ever diminishing returns.
Efficiency can also include non-tangible value. A lot of people want to own Tesla shares because it makes them feel cool or techie, so it trades at a huge premium over the fundamentals. But it doesn't change the fact that if there is an expected increase or decrease in company performance, the going share price will still adjust amazingly quickly.
So "efficiency" is really in the eye of the beholder. One person can look at a circle from 10 feet away and say, "look a perfect circle!" and the other can say "there are no perfect circles" and the second person can be technically correct, but the first person's observation may be perfectly valid.
The idea that markets approach efficiency is a hypothesis. Markets could also approach maximum exploitation. That is another hypothesis. Which one is better at explaining any given economic system is a matter of interpreting the data and trying not to lie to yourself.
The problem with most of economic science is that latter part. Where most other sciences try to decouple themselves from their subject or at least aknowledge the limitations of their field, many economists seem to have a much more loose relationship with their field. E.g. if a hypothesis failed to explain so many real world phenomena as many popular economic ideas, any natural scientist would throw their hands in the air and admit they had no idea what was actually going on. Yet my feeling isn't that economists are like: "We have that part here figured out and that part over there is work in progress" but more of an airquotes-science, like Lacanism or Freudianism, where what you say depends on whose school of thought you subscribe to.
Granted if one imagined how a truly serious about describing-what-is-economic-science would have to work like, that would be a gargantuan endeavour as it not only encompasses mathematics and complex systems, but also fields like psychology, sociology and geography. So I am the last to blame any serious economist for not being able to explaining everything. What I can however blame them for is when they defend a hypothesis that has been falsified by reality countless times by moving the goal posts by saying the conditions have to be just right for their hypothesis to make sense. Yeah sure.
History of economic thought should be covered in Economics 101 to really drive this point home. Going through the entire history of the discipline you recognize that the practical purpose of economics is mainly serving to justify a society wide experiment on why the latest theory is wrong.
Your critique of the field would be largely correct a half century ago when theory and ideology reigned, but if you speak to any group of econ doctoral candidates today I think you'd be surprised how hard they're genuinely striving to root themselves (and the discipline at large) in empiricism and evidence-based thought.
The old guard still runs the show, of course, and the field will advance one death at a time.
I'm not sure if you read the article in question - but it is literally interviewing Fama (the person who coined the term "efficient market hypothesis) about ways markets continue to be inefficient.
Regardless of how much efficiency there is or is not, it's still a good theoretical framework for understanding markets. No one assumes the cost of a wheat future is a completely made up number so obviously there is some efficiency.
My point wasn't about the hypothesis of efficiency per sé. It was about the field of a whole.
I have nothing against useful tools or models. But all too often these get confused with reality in economics — with potentially world-changing consequences. Granted this wasn't the point of the article, it was more like a tangential thought.
Efficiency and exploitation are not mutually exclusive. Efficiency is usually defined as "maximizing output while minimizing input". Exploitation is about how equal the deal is, whether the returns will be spread evenly across all people who contributed vs. concentrated in one person. There are a great many situations where the most efficient way to produce something is to have one person tell lots of people exactly what they should be doing and then work them as hard as possible while giving them the minimum needed to induce them to take the job. The whole profession of management and theory of a firm is based on this idea.
Many people would agree that efficiency is good while exploitation is bad, but we shouldn't let our feelings toward each idea cloud our understanding of the relationship between them. It's very possible for a concrete situation to be both good and bad at the same time, depending on which part of it we look at.
This isn't too much of a thing for stocks (most likely because they aren't production inputs), but that's a small part of price signals. In general, the most important prices do not adjust amazingly quickly, because our economy is far too slow and unwieldy and unable to cope with price uncertainty.
Rigidity is not thought to be about attributes of the markets, it is a consequence of the productive process that belies them. That it only applies to inefficient markets is circular reasoning, if rigidity makes a market inefficent then surely it applies to inefficient markets.
Stock markets are ultimately downstream of production, it is impossible to divorce the efficiency of commodity markets from the efficiency of capital markets. Rigidity is contagious.
Firms with sticky prices are wildly considered to incur costs and more negative responses to various macroeconomic conditions, and those costs reduce the valuation of equities, so the inefficiency in production is reflected in equity prices. If prices were not rigid we would see different equity prices.
You can try to fix this by looking at every transaction level in isolation and baking in the bias of the next level, but then you're no longer making a statement about the economy and the efficiency of price signals.
Instead, you're making an essentially unverifiable statement about the profitability of a limited set of strategies restricted to long/short positions in equities only (which on average is forced to be exactly equal to the market price since every transaction needs a counterparty):
Even if there is a hidden variable that makes some strategies better, it will most likely be impossible to pick out which strategies are better because of luck and which are better for a reason if you are modelling the null hypothesis as some sort of random walk with long tail event, the hidden variable will most likely be lost in the noise.
You can also try testing it by looking at prices directly, in which case Roll's critique holds.
In short, as a broader theory to apply to economic relations and economic calculation, the EMH doesn't hold. As a narrow theory of the profitability of certain trading strategies, it's unverifiable.
Maybe this is a revelation to…someone? I don’t know why Eugene Fama saying this in 2024 is considered news. The guys entire body of research since the 1960s is about market inefficiencies.
Amazing that 100 years later we’re still unable to grasp the nuance of the efficiency idea.
We settled this one forever ago, but somehow armchair internet commenters still think they can zing the entire field of economics by saying “lol you guys still think people are efficient robots.” Cool 1940s insult, bro.
Yes, obviously markets aren’t perfectly efficient and nobody believes they are. But they trend toward efficiency over time. Ignore this at your own peril.
Fama himself proposed the efficient markets hypothesis, to some acclaim:
EMH is the closest finance has to a “theory of everything”, and won Fama the Nobel Prize for Economics in 2013. But it remains as controversial today as it did when Fama first proposed it half a century ago.
(From TFA.)
The fact that the hypothesis's own formulator and presumably chief cheerleader now has his doubts is worthy of comment.
Because "now has his doubts" adds a temporal change that's incorrect. There is nothing in the article that says he's "now" had a suddent shift. He has formed no new "doubts".
Fama has always made the distinction that it's a hypothesis, not reality.
e.g. 'I start my class every year by saying, “These are models. And the reason we call them models is that they’re not 100 percent true. If they were, we would call them reality, not models'. https://www.minneapolisfed.org/article/2007/interview-with-e...
So I agree with the GP, "I don’t know why Eugene Fama saying this in 2024 is considered news."
The context of the headline is a current interview with Fama, and the fact that the conversation focuses largely on EMH.
Which makes litigating of the title tedious, and failing to fullfil HN's objective of satisfying intellectual curiosity. Dang explains this (in a somewhat different context, but otherwise relevantly) here:
Fama's actual position was of course more nuanced than simply declaring that "markets are efficient".
His key EMH paper [1] notes that a generic formulation of the EMH, that security prices at any time "fully reflect" all available information is untestable: you need narrow down the information set and the pathways in which they are reflected in prices. The paper goes over various technical definitions of "efficiency" and concludes from reviewing the empirical literature (in 1970) that no evidence against certain formulations (weak, semi-strong) of the EMH has been found/published.
I don't think it's fair to characterize Fama as "chief cheerleader" of the EMH, but the papers are there for the readers to judge for themselves.
The trouble is that, even if this is true, there is no theoretical upper bound on how long it can take. If "markets trend to efficiency" means "don't worry, wait a few years and this inefficient market will be efficient again", then that's one thing. If it could take a couple of hundred years, that's quite another. As Keynes famously put it:
> In the long run, we're all dead. Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again.
There's an interesting analogy with non-Turing-complete programming languages that guarantee program termination. In the real world, a guarantee that a program will terminate eventually is often not particularly useful. What we really want is a guarantee that it will terminate within some reasonable period of time.
Simply reading an introductory article on the efficient market hypothesis would be a good starting point here, because both of these are basic principles. Efficiency in this context means how quickly and accurately the market incorporates information into asset prices. A very simple example would be a company giving an earnings call, how quickly and accurately after the results are known does the stock price move to reflect the results. If it happens quickly and accurately, the market is efficient, if it takes a long time or is an overcorrection, the market is inefficient. Now expand this concept to all available information at all times for all assets and you roughly have the efficient market hypothesis. Naturally no one thinks that the market is perfectly efficient at all times, but depending on how clear of a signal there is based on available information, the market can be really darn efficient at times.
except in the case of the efficient market, if somebody manages to find some inefficiency, they can stand to profit off it by arbitraging that inefficiency (until it disappears).
So it's not quite the same as code inefficiency, unless an engineer could reap the reward for the fixing of said inefficiency.
This isn't true. If you manufacture inefficiency yourself, and control it, nobody can exploit it. In fact if they try to, you can exacerbate the inefficiency in the other direction. Try arbitraging against the inefficient pricing of GameStop.
I don't see how you can manufacture and control inefficiencies in the long term so that nobody can exploit them. How can you arbitrarily exacerbate the inefficiencies?
More money has been earned by removing the GameStop inefficiencies than by creating them. GameStop shot up in value driven by WallStreetBets, but those people mostly lost money by creating the inefficiencies.
Introducing them has made people money. Those people will seek to introduce them again under a different ticker.
The main inefficiency in GameStop is creating information and will to buy that runs completely orthogonal to the actual valuation of the stock. Like snake charmers, Roaring Kitty etc use memes and bots online to drum "bagholders" into a fervor, thinking they are righteously sticking it to some nebulous man by buying a stock that is worthless.
Ah, so it is like the "Bug Free Code Hypothesis". If someone is paid to write code, then theoretically that code should be making money for someone, and it should be making them more money if all the bugs were fixed.
Not exactly, but I think that analogies with everyday experiences can help to show how silly some of these hypotheses are when considered in more concrete terms. “People have lots of incentives to eliminate Xs, therefore there won’t be any Xs” is an argument schema for which counterexamples abound.
To be fair, the "Bug Free Code Hypothesis" is kind of true. Because there are lots of incentives to eliminate bugs, people do put a lot of time and effort into doing so – yielding modern miracles such as OS kernels with 30 million lines of code that almost always work as intended.
But while software is bug free to a perhaps surprising extent, it would be foolish to plan a software project on the assumption that there will not be any bugs to fix, or that a small number of bugs cannot have a big impact. Similarly, it seems unwise to assume the efficiency of markets in economic planning (though I don't know to what extent economists actually do this).
I'm wary to using analogies of smaller team dynamics for wider systems. Markets have a disconnected impersonal nature where things have a way of shaking out.
Most of those programming management memes come from big companies with giant teams that don't live or die on output, many of them are shielded from that sort of thing because of cash cows like Microsoft/Google or corporate megadeals like IBM/Oracle. So there's never any shake ups until it's long been obvious to the customers.
I'm not using an analogy of smaller team dynamics. One can talk about software bugs in general and the general incentives to fix them just as one can talk about the economy in general and the general incentives for people to make money.
I'm also not referencing any programming management memes.
I think maybe you're seeing a cynicism in my comment that's not there. I don't think that bugs exists because of dumb managers. I think they exist because it's very difficult to write code without any bugs, even when there are very strong incentives to do so. That's partly just because it's inherently difficult, and partly because there are also other incentives pulling in different directions.
There are a substantial minority of people, mainly on the political left in my personal experience, who characterise capitalists / economists as using theories where the market / consumers are perfectly efficient. To me it seems one of those phenomenons where people want to have an opinion on a complex subject, but to do that they need to simplify it to an extent that makes it a completely innacurate caricature, often based on information that's many decades out of date. It drives a friend of mine - who's an experienced economist that builds models of economies - absolutely mad when people blithely say "but of course you believe that people act rationally and markets are efficient".
I've never once seen anybody on the left use this argument.
On the contrary. It is a religious chant on the Right, that Free Markets are efficient, and The Free-er, the More Efficient, and will solve all of our problems.
--> "All hail our god the free market, efficient in its repose, elegant in its demonstrations, arbiter of logic through the efficient drive of profits, holy in its dispensation of moral judgement, let those that are poor be scorned for the market has judged them unworthy of its riches".
I think you misread my comment. I'm saying that's how the left unfairly characterise capitalists / economists, which is particularly unfair in the case of economists.
Yeah, I re-read it. Still missing it, are you saying the left un-fairly over-simplifies it. OR the Left portrays the right/economist as un-fairly over-simplifying?
I'm saying the left (not everyone by any means) unfairly oversimplifies the views of economists. Absolutely no-one who is taken even vaguely seriously in economics thinks that consumers are rational or that markets are 100% efficient.
Guess, I'm retorting, that is not a 'left' point of view. The 'right' also oversimplifies views of economics. I would argue, the 'right' is even more guilty of it, like promoting false economic concepts is their bread and butter, part of their platform.
Though, I can agree, maybe it is, most people all around, only have a simplified view.
Macro-economic forecasting mostly works but the size of the error bars on the computations are directly proportional to the potential informativeness of the forecast. Micro-economics is a bunch of toy and niche models, where the accuracy of the model is generally inversely correlated with how broadly applicable it is.
Economic theory is kind of bullshit, they're building predictive models of enormous complex systems and trying to ascribe meaning, the models can be "ok" but the meaning the economists give is personally biased hand waiving about 100% of the time.
I kind of feel like your second paragraph is helping prove my point. And in my experience the people who build these models are very aware of their limitations (even if some of them do then go on to make overly broad conclusions for publication).
The problem is that economists love to ascribe meaning and make confident statements about causality in order to promote personal ideology rather than let the models speak for themselves. These models predict behavior within a narrow range of conditions, but that doesn't tell you anything about the underlying systems. You can model any function over a restricted domain using polynomials, but that doesn't mean that polynomial function is the ground truth of the universe.
I understand that economists are essentially saying that the markets are efficient in the sense that public information is factored into the price of assets in real time. My issue with this idea is that many human beliefs are founded on collective delusions. The market can stay irrational longer than you can stay solvent. So the distinction in the definitions of efficiency doesn't matter since public information and knowledge is highly flawed. What does it mean if incorrect assumptions are factored into the price? It doesn't make sense to call that efficient.
I guess it's efficient in terms of ensuring that the prices of assets reflect the social conditioning and incentive structures laid out by the overarching legal and monetary system.
It's the same as "trickle-down economics", known to be untrue but the original belief is memetically stronger and sticks around. Simple "truths" are easier to believe in... (and easier to regurgitate in short-cycle attention[-span]-deficit news)
It's not the same at all. Efficient Market Hypothesis is the actual given name of an economic hypothesis. "Trickle Down" economics is a derogatory term applied to a number of controversial economic policies, by opponent of the policies.
The point of discussion was about how "this is a revelation to…someone?" My response was concerning concepts sticking around in wider popular discourse despite being known to not apply particularly well. Did you read past the first 6-8 words?
> Maybe this is a revelation to…someone? I don’t know why Eugene Fama saying this in 2024 is considered news. The guys entire body of research since the 1960s is about market inefficiencies.
Because there are still significant numbers of people, many of whom are in positions of power, who think that increases in market efficiency solve all problems in a society.
When you have people thinking that shortages of things like "food", "medicine", "shelter", and "water" can be solved by simply adjusting prices until some people can no longer participate in the market, you don't have a hypothesis, you have a cargo cult, and a psychopathic one at that.
They don't seem to. People who exploit the reality of markets, that they are vulnerable to hype and speculaiton, seem to run away with more and more money, leading more and more people to engage in fraudulent SPAC dumps, meme stocks, lobbying for Trumpian deregulation, Tesla levels of fanbase engineering, and wash trading crypto coins.
The market is rife with information asymmetry that seems to be increasing, and for it to trend toward efficiency, we would need that to be trending downward.
It may surprise you to learn that these obvious ideas are older than you think. Wikipedia it.
In fact, one of the main errors in Karl Marx’s theories from the mid-1800s was the belief that
markets were perfectly efficient. He thought profits in a market economy would inevitably fall to 0.
It turns out humans constantly want new and different stuff, in unpredictable fashion, and therefore this never happens.
Another one being the Intrinsic Theory of Value which he borrowed from Adam Smith. Marx allegedly postponed the publication of the 2nd volume of his Das Capital, when he learned about Marginalism, as it would require a complete revision of his theory, but died before he could do it. Von Mises writes that if that's true, Marx was way smarter than his followers.
While this is the “armchair internet commenter” narrative I was talking about that everybody has parroted going back to the news group days, it just isn’t true.
Do you actually believe everyone in the entire field of economics believes people are robots? Or is it just convenient for you to hold that belief since it allows you dismiss an entire field of human endeavor in one sentence?
> Do you actually believe everyone in the entire field of economics believes people are robots?
They don't, but a lot of them work (and preach) as if they are.
This is not perculiar to economics, but rather a general practice of scientific programmes in the Lakatosian sense. But few fields cause such harm with and are so politically motivated to protect their core assumptions.
E.g. DSGE models are still rather popular with academics and practitioners. And the classical economics is largely how economists popularize their field and justify policy.
As pretty much any professional trader or quant knows, there are degrees of efficiency. Ex-US markets are significantly less efficient than the US. Some US securities are less efficient than others. Certain instruments and exchanges are less efficient than others.
Markets become more efficient as a result of entities who make them so. It is possible to make a very good living by being one of these entities.
I think OP is referring to brokers and market makers, whose role is to help match buyers and sellers and to maintain liquidity in certain securities, respectively. In which case the time scale would be small (you don’t want to be caught holding something for too long if you’re just a middle man)
The efficient market hypothesis, like many things in economics, has been named in a very ideological way (Fama himself agreed with that). First of all in has nothing to do with markets in the general economic sense, as it's merely about financial markets. And then it has nothing to do with “efficiency” in any sense (neither the common sense or the usual economic sense of the word).
In fact it's kind of the opposite of efficiency, because when the efficient market hypothesis is true, then it means that the market makers are losing money compared to the passive investors, and that's very inefficient: it gives nobody an incentive to perform the work of capital allocation and instead incentivize everyone to be freeloading on other people's work.
As relationships persist, the information content on the channels of said relationships diminishes in exchange for information efficiency. The channel becomes the omnipresent information. With a budget on information consumption, as the balance of persisted channels increases, the total actual information content circulated diminishes and replaced by "heartbeat" messages in established channels. The efficient society prunes relationships by means of time and circumstances to optimise information exchange. How Zuckerberg's innovation affected the efficiency of society is up for grabs. Disclaimer, this is not an actual theory or research based facts, just a random person responding to the challenge of parent.
If markets were perfectly efficient there would be no entrepreneurs.
To start a business of any kind is to hypothesize the existence of a market inefficiency, something the market is not currently doing that would make it more efficient. All business is in some sense arbitrage between state A, the market as it currently exists, and state B, the market with your business in it. A business succeeds if its hypothesis is correct and if it executes well.
That's a different definition of efficient than efficient-market theory. The theory is about the efficiency of the value of assets in the market to new information. It isn't about the efficiency of the businesses in the market or the market overall. The stock market prices are efficient, not the stock market companies.
Efficient-market theory doesn't apply to startups because they aren't listed on the stock exchange. The theory doesn't apply to small number of investors like VCs. It definitely doesn't apply to the business of the startup, or to the reaction of the market to the startup. It does apply when the startup goes public.
Presumably that wouldn't be the case for any innovative companies, though. There might not be Richard Bransons storming into existing markets and dominating them, but there would still be Microsofts and Googles.
You're assuming that startups are more innovative than large companies, but this is only true because the market is not efficient. An "efficient" enterprise would perfectly invest in innovation.
emh doesn't mean everyone knows everything, it means the price accurately reflects available information. if an innovation was believed to be world changing, it would be worth a lot, if the belief changes, the price changes.
And there is one problem: "belief". Some people can walk through Xerox PARC and bet their company on 3-4 things they see. Others can own Xerox PARC and bet their company on 3-4 largely different things.
In EMH there is cooked in some notion of overall largely rational beliefs, and yet the shares trade hands from someone selling to someone buying - both of which feel they got a good deal worth making money from.
i mean, if you want to go all epistemological, sure, let me rephrase. each of us individual humans live in a specific world mapped on what we believe we know and our lived experience, and there is (at least) one unique world for each individual human. the price is a representative agent of a subset of the worlds that exist within the minds of the participants of the economy. as the mappings of reality upon the beliefs and experiences of the individual participants change, the price changes.
The economy is a faith-based construct. Prices aren't set by "information", but by faith in value - which is one of the easiest things in the world to lie about.
Why would anyone finance an innovative company if financing companies yourself was always less profitable in the longer term than passively investing (which is what efficient market hypothesis is about)?
In fact if the EMH was true, then all hope for financing innovative companies would come from delusional investors making the sub-optimal choice of investing there. How “efficient”.
But the market only has access to public companies. It wouldn't know about anything non-public, would it? And when a company went public, in a perfectly efficient market all the share prices would instantly rebalance to take that new company into account.
> It wouldn't know about anything non-public, would it?
Why? Then how would be all your stealth companies supposed to raise enough money in the first place? Or attract customers?
In practice most companies are publicly known as early as series A at least and remaining unnoticed for longer requires lots of effort that would definitely hamper the growth of such companies.
And the market definitely takes rising competitors, even private, into account when assessing the financial prospect of existing public companies.
But not all information is available to the whole market. Otherwise fully private startups would also fall under it, as, well, the employees know the information, so it's technically "available".
That definition of EMH seems to be what's causing this idea that innovation in new companies is impossible, rather than the general idea that asset prices reflect available information. Some information is not available, and that won't be reflected in prices. That's all.
It is if you factor in the fact that innovative companies need some kind of financing to begin with, and that if the EMH was true, then it would be irrational for any investor to fund them.
Nope. When conditions change in the world, that creates a gap in the market. Even if everything were perfectly efficient now there would still be a need for markets to change tomorrow
Lots of comments here are related to "efficient" and "market", but completely unrelated to the "efficient-market hypothesis"[1].
The efficent-market hypothesis is not general supposition that for example all markets are efficient by all definitions, nor that free-market capitalism is efficient. It's a specific hypothsis the prices of financial assets like stocks represent the true expected value[2] of the assets, including when accounting for future retuns. The supposed mechanism driving the property is that finacial asset markets are effectively servo systems[3]; traders trade based on any measureable information and act as feedback which drives prices to the expected values, so any other variables which may affect prices are therefore unmeasurable.
Personally, it seems clear to me the hypothesis is literally false. Someone has to have the most actionable information or be the best at measuring. On the other hand, it seems clear that it's practically true for almost all people. The chance that any given person can measure an asset's true value the best is practically negligible. I certainly don't believe I can beat the market.
I was with you until this step. That markets are not close to efficient (in the sense of EMH) seems right to me. BUT it does not follow that because of that anyone should be able to beat the market.
There is a huge gap between EMH being far from reality (or simply not close) - and that gap being exploitable. (Or more generally, non-EMH doesn't say much as to whether or how things should be exploitable.)
For one thing we humans are humans, report to humans, get our news from humans, share this market with humans, etc, and the ones of us who pay attention know how hard it is to account for that.
Robert Shiller, who had long been one of the most vocal critics of the efficient market hypothesis and the idea of efficient markets, shared the Nobel Prize in economics alongside Eugene Fama in 2013. Shiller is also well known for the Case-Shiller Home Price Index.
Markets are efficient. At measuring who cares enough to calculate the price of something, who is exploiting it via fraud, how much society cares enough to investigate that fraud, how good the business actually is, how many people are pumping the stock without knowing anything about it, how many people are dumping the stock without anyone knowing about it, how many people have a grudge against the CEO, how many people want to have the CEO's babies, etc.
That they are efficient in communicating what a company is worth on fundamental financial level is laughably incorrect and not even worthy of "in best case scenario" theorizing.
What they are efficient at is capturing literally EVERY possible human motivation to buy, sell, or ignore, and distilling it into a single number.
I think it’s a useful model to understand what should happen under ideal conditions, but it’s not true 100% of the time as participants don’t always act rationally or make correct preditions about the future.
It’s a pretty good tool for analyzing markets and understanding what’s happening. Like anything, it’s impossible to create an abstraction that’s 100% correct or works in all circumstances when discussing a massive dynamic system that is the real world and life.
Interesting hypothesis. But what is the speed of news when filtered through the brains of whole populations of people? It often takes people some time to come to terms with new information to the point where they feel comfortable to reshare it with others. Cognitive dissonance is a powerful resistive force.
The study of the spread of memes is something that's the subject of research currently.
A very good discussion about market efficiency with Fama and Thaler from a number of years ago (maybe a month or two before Thaler won a Nobel Prize): https://www.youtube.com/watch?v=bM9bYOBuKF4
Nobody sensible believes that financial markets are perfectly efficient.
On the other hand, nobody sensible believes they are completely inefficient, or trivially beatable. If you want evidence of this, feel free to go out and beat the market with long plays on the alpha you imagine you have.
I think it's usually helpful, when trying to understand the world, to think, "markets are pretty efficient, do they agree with me? If they don't, can I think of a real reason why this may be a case where they're wrong, or am I just engaging in wishful thinking?"
I think it is not usually helpful, when trying to understand the world, to be really mad about the EMH.
If markets just randomly assign values to companies, you can beat them in two straightforward ways:
1. Just buy when the price is low and random variation will move the price higher eventually (or short when the price is high).
2. Ignore the market except to buy when a company is underpriced, then just have the company declare dividends or whatever and directly eat the profit that the market is stipulated to have underpriced.
A very small investor in a random market might have difficulty with either of these strategies, but a reasonably well-capitalized investor would not.
If you want to think up some kind of complicated model of difficult-to-take-advantage-of company pricing that is hard to exploit, really ask yourself whether that model is grounded in anything other than, "I'm mad about the EMH."
If the market is assigning random values you could easily just use the uniform distribution to model what is high or low; Intuitively the median would the demarcating line.
Companies never have a negative price. Also, just look at stock graphs. Companies are not priced by geometric browning methods.
This is what I mean when I say that it's usually not helpful to try to make claims about the world based on, "I'm really mad about the EMH." You end up making silly claims.
> Companies never have a negative price. Also, just look at stock graphs. Companies are not priced by geometric browning methods.
Geometric Brownian motion can't take negative values either, so I don't know what you think this proves. While it's true that stock prices don't literally follow geometric Brownian motions (+drift), you can't tell the difference from stock graphs. (You can tell the difference with statistical tests if you know what to look for, e.g. volatility clustering, but humans can't tell by eye, and naive classification ML models will not perform well.)
I admit that I assumed that "geometric browning motion" was just "a random walk with more extreme movements when it goes away from the starting place," and that was wrong. What geometric browning motion in fact is, with some handwaving simplicity, is exponential growth with some jitter.
I will note that "stocks are priced via geometric browning motion" would satisfy the EMH. And that the underlying growth trend of GBM, in a real world, is, like, "the stock market actually values real things about the company that you can find out, but which other people have already found out."
Some people, like Warren Buffett, do exactly that. But the forecasting is very difficult. It's a full time job for them, and they have the industry connections to obtain information that you or I can't.
Buffett says he doesn't generally believe in market forecasting, he sticks to figuring the prospects of individual businesses, which simplifies things a bit.
If it's random (I assume that's what you mean by "chaotic") then it's efficient by definition because future price changes aren't a function of historical prices or publicly available information.
That’s exactly it. I view it almost like Newtonian physics. Sure, it’s inaccurate at some level, but until we find a superior model, it’s safer to make your investment decisions based on it.
The market (in any good) is an information processing system which tries to collate a colossal number of variables down to a single one: price. It has the same limitations as other information processing systems, as well as things you may be familiar with from control theory like frequency response.