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Kindly Stop Saying the Efficient Market Hypothesis Is Dead

61 points by jacobedawson 6y ago

raverbashing 6y ago
I think there are two important aspects that make the EMH not a good predictor: - The markets move the prices themselves, so the prices are not the "canonical" ones (if there was ever such a thing) but it reflects the idea that the market itself has. Betting on a certain outcome in a game doesn't change the possible results, "betting on the market" does. So it's less about the "reality" and more about what the market thinks. The second aspect can be summed up by the phrase "one person is smart, but people are dumb" (with the added component of "the market can stay irrational longer than you can stay solvent") So, the market is probably not efficient but that doesn't mean you can beat it with ease.
mewpmewp2 6y ago
Finally some sense. I am so tired of people complaining about markets being irrational
greatwave1 6y ago
Here's a dashboard I made that tracks the performance of the average Robinhood user vs. the S&P 500 (using user holding data): https://www.quiverquant.com/sources/robinhood https://www.quiverquant.com/sources/robinhood There's an argument to be made that the ability to consistently UNDERPERFORM the market is evidence against the Efficient Market Hypothesis.
- Natsu 6y ago
  Alternatively, it means that someone has an edge that can be used to exploit RH (or maybe even all retail) investors. Given the state of the market, this seems ... disturbingly likely.
- trader1 6y ago
  Trading costs are a thing. In an efficient market I would expect ex-ante negative performance versus the benchmark.
  - greatwave1 6y ago
    True, although the method I used to find the aggregate performance of Robinhood users ignored trading costs. Obviously this data is incredibly noisy and nowhere near statistically significant, but I like how it implies that betting against Robinhood traders would've been an alpha-generating strategy over the last two years.
    - trader1 6y ago
      I agree that the data is quite noisy, and the choice of weighting (by users instead of dollar value traded) may significantly influence results. Then again, after reading r/wallstreetbets, I am not so sure ;).
      - greatwave1 6y ago
        Yeah, unfortunately Robinhood doesn't provide data on # shares held per user. I've been doing something similar to track discussion on r/WSB here: https://www.quiverquant.com/wallstreetbets/ https://www.quiverquant.com/wallstreetbets/ I haven't finished any backtesting yet to see if they live up to their reputation haha.
  - throw0101a 6y ago
    William F. Sharpe mentions this explicitly in "The Arithmetic of Active Management" (The Financial Analysts' Journal. January 1991, Vol. 47, Issue 1, Pages 7-9). He was a co-creator of CAPM (won Nobel) and did the Sharpe ratio: * https://en.wikipedia.org/wiki/William_F._Sharpe https://en.wikipedia.org/wiki/William_F._Sharpe
- throw0101a 6y ago
  Or it's all the sports fans not having any other way to spend their time: > They started betting on what color car would pass next * https://twitter.com/SportsCenter/status/1264026863367786496 https://twitter.com/SportsCenter/status/1264026863367786496
  - ivalm 6y ago
    Sure, but part of EMH is that stocks are priced correctly, therefore in aggregate you would expect any sufficiently large collection of random portfolios should have the standard market return.
- s1artibartfast 6y ago
  That’s an interest question. What are the application for a rational actor in the EMH? Can application be reduced or applied to a subset of actors. What are the predictions for a random or misinformed actor in the market?
- sukilot 6y ago
  That chart shows Robinhood as randomly above and below S&P500
wizzwizz4 6y ago
A slightly different, more complete version by the same author can be found on LessWrong. It has some clarifying edits (written in small writing), and there's more discussion in the comments. https://www.lesswrong.com/posts/utySCY9nJt9xGYGGQ/the-emh-aten-t-dead https://www.lesswrong.com/posts/utySCY9nJt9xGYGGQ/the-emh-at...
- deleted 6y ago
  [deleted]
lisper 6y ago
For any big market movement you will always be able to find the person who acted on it first. That person will always look like a prescient genius if you just look at that one data point. To show a counterexample to the EMH you would need to exhibit someone who can consistently beat the market at odds better than chance under proper controlled conditions. No single data point can ever do it.
- Retric 6y ago
  The real problem with the EMH is most people consistently do worse than the market not better. In a completely efficient market every trade should be equivalent, but when you look at what happens when millions of the uniformed try and day trade they on average lose massive amounts of money. PS: I have tried to time the market exactly 4 times and it’s worked every time. That does not mean the EMH is dead, that’s just like how I am actually up on slot machines and have decided never to play again.
  - lisper 6y ago
    Right. To show the EMH is dead you have to show that someone can beat the market with odds better than chance under properly controlled conditions. In a market with millions of participants, you would expect there to be a few who beat the market purely by luck many times in a row. In fact, in a population of a mere one million people, you would expect to find one person who beat the market 20 times in a row without a single miss by pure luck! Four for four is not even remotely remarkable. One person in every 16 will be able to do that.
    - RookyNumbas 6y ago
      Sure, that's all correct. But before showing it is dead it would be useful to have empirical evidence that it was ever alive. And the evidence is very mixed at best. The history of the EMH is a battle between those showing where it breaks from reality, followed by increasingly desperate attempts to save it with some additional explanatory factors. It's a nice model. But like most economic and financial models shouldn't be held as gospel.
zenlot 6y ago
EMH is dead.
vmception 6y ago
Efficient Market Theory is dead because it is unfalsifiable. It is not capable of being proved false, and should be discarded for that reason. Information asymmetries exist, not everyone with better information have the access to capital or risk profile to alter the market price of an asset.
- s1artibartfast 6y ago
  Does information or performance asymmetry disprove the theory?
  - vmception 6y ago
    assets can be mispriced, efficient market theory requires stretching the logic to fit the theory. it requires a moving the goal post of to a longer and unspecific time frame to say that someone's outsized gains now are irrelevant, it requires moving the goal post to a greater unspecific amount of capital to say they can't beat the performance of the benchmark. anyone in any hard science will point out that the theory is unfalsifiable so pick a different theory. why are we making exceptions for economic and financial theories at all?
- aaron695 6y ago
  Your first two sentences are very interesting. > Information asymmetries exist, not everyone with better information have the access to capital or risk profile to alter the market price of an asset. This is talked about in the article and seems to just start an argument again and not explain the unfalsifiable statement.
  - vmception 6y ago
    Sorry if that weakens the argument to you. It is a separate thought. My point is that "asset pricing" theories are too reductive, and should at least factor in undercapitalized people that do not wish to speculate that can perceive information. Or just abandon reductive asset pricing theories and focus on other things. Promote liquidity and increases in transactions, "efficiency" in that context, not "efficiency" in a "it already is and has been all the time and forever" context.
nickpinkston 6y ago
More interesting than "Is EMH dead?" is our improving understanding of the efficiency of incorporating new information into markets is getting better. I'll refer you below to Andrew Lo's "Adaptive Market Hypothesis" which: "is an attempt to reconcile economic theories based on the efficient market hypothesis (which implies that markets are efficient) with behavioral economics, by applying the principles of evolution to financial interactions: competition, adaptation and natural selection."[1] [1] https://en.wikipedia.org/wiki/Adaptive_market_hypothesis https://en.wikipedia.org/wiki/Adaptive_market_hypothesis
trader1 6y ago
The article reads like it was written by someone who has a deep interest in finance, but hasn't worked much in the industry. Markets are quite efficient, but there are pockets of risk premia driven by regulatory/intermediary constraints and plain old behavioral bias. Then again, if he knew about them, he presumably wouldn't write about them in an internet blog post.
arminiusreturns 6y ago
Money printer goes brrrrrr. Effecient markets!
ivalm 6y ago
One thing this blog doesn’t address is price elasticity/liquidity. There is far less friction and chance to get front-run if you are dealing with $100k rather than $100M.
erokar 6y ago
Markets are not rational, they exhibit crowd psychology and as such are more primitive and irrational than individual behavior. Quite a few professional traders, hedge funds and even retail traders consistently outperform the indexes. They are able to do this because they have recognized the fallacy of EMH and are able to exploit the market's irrationality.
- throw0101a 6y ago
  > Quite a few professional traders, hedge funds and even retail traders consistently outperform the indexes. In any one year there are a number of them do, but SPIVA has shown that over the course of 5, 10, and 15 years that number gets smaller and smaller: * https://us.spindices.com/spiva/#/ https://us.spindices.com/spiva/#/ Also: just because the market is not 100% efficient, and some folks can find 'weaknesses', does not mean it is not mostly efficient. * https://yourlogicalfallacyis.com/black-or-white https://yourlogicalfallacyis.com/black-or-white Not even Fama, whose is often credited for formulating the EMH, has said that it is 100: * https://en.wikipedia.org/wiki/Eugene_Fama https://en.wikipedia.org/wiki/Eugene_Fama
  - throw0101a 6y ago
    Replying to myself on the SPIVA point (PDF): > Over the 15-year period ending June 2019, 90% of large-cap, midcap and small-cap funds underperformed their benchmark S&P indices. In only one asset class, large value (80% underperformed), was the percentage of underperformers below 86%. * https://www.advisorperspectives.com/articles/2019/11/18/the-surprising-results-from-s-ps-latest-spiva-analysis.pdf https://www.advisorperspectives.com/articles/2019/11/18/the-...
  - ternaryoperator 6y ago
    I don't disagree with the point you're making, but I should point out that one reason some funds don't beat the S&P500 is because of the fees they charge, which are deducted from their performance. In reality, their actual gross performance is better than the S&P. However, the fact that the results are so close to the S&P's performance that the fees alone can push them below it supports your overarching point.
matthewdgreen 6y ago
This seems like a silly point. Are markets more efficient in the infinitely long run than an individual who tries to identify the "correct" price? Quite probably. Does the current stock market price at any given moment possibly reflect the herd mentality of a bunch of jumped-up plains apes (or the injection of a huge amount of funds by a central bank), rather than representing the future expected earnings of a given asset? Also extremely likely. The performance of the markets during the lead-up to the pandemic was absurd. It wasn't just the top-line market prices that were wrong: the obvious hedges, like Put options, were all massively mispriced, to the point that even banks started warning about it. This eventually corrected, but the correction itself was extremely painful. Now the Fed is injecting dollars in order to help "correct" the correction, with unknown long-term effects. (I don't know what the EMH has to say about prices under this regime.) Anyway, "the EMH is wrong" is an absurd simplification of the problem. The real objection here is that asset prices may be right on average, in the long-enough term, but are prone to huge over-confidence bubbles and corrections that can wreak havoc on the actual human beings, and possibly lead to suboptimal economic outcomes when prices are used to direct investment.
- JumpCrisscross 6y ago
  > obvious hedges, like Put options, were all massively mispriced As a former options market maker, this wasn’t obvious. That said, every time volatility snaps one tends to find a cohort of investors who got burned blaming the Fed.
- rmrfstar 6y ago
  EMH is a mental-model of equilibrium, and is useful when used that way. Financial systems have multiple equilibria [1], so EMH "violations" come in two flavors: 1. Small deviation from equilibrium. This is where Renaissance Technologies hangs out. 2. Market herd expects the wrong equilibrium. This is where Nassim Taleb hangs out. On the scale of single years, 2 happens so rarely than you can't get statistically significant measurements. So, we end up with endless philosophical debates about whether EMH is "true". [1] https://en.wikipedia.org/wiki/Diamond%E2%80%93Dybvig_model https://en.wikipedia.org/wiki/Diamond%E2%80%93Dybvig_model
- 6y ago
jkhdigital 6y ago
“The Market” is a leaky abstraction for the collective activity of millions of individual humans making concrete decisions at specific points in time. The EMH says something about the model, not about reality, so there will always be a gap.
deleted 6y ago
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meesterdude 6y ago
First off, I don't like titles telling me what to do. You're not my real mom. Second, this was more incoherent babble than useful. While I am an investing nerd, this article could be about 1/3rd as long. The rest was trash writing and ego. Third, there is some worthwhile content in that 1/3rd that's good. But it's nothing groundbreaking or new, and detached from the EMH topic. His perspective on Warren Buffet was worthwhile, though, and the idea that once a tactic goes public the collective abosrbes it and the edge is lost is worth pondering over, and the comparison of using a stone-age axe against a fighter jet is meaningful too. There's no real discussion around the lifetime of tools, techniques, and perspectives. That might be the most worthwhile takeaway for me. Forthly, equating market action to coin tossing is intellectual laziness. I would agree with this on an intraday trading level, but in long term investing that's just not the behavior equities exhibit. Lastly, my portfolio has beat the S&P500 by significant margin (>3-8x) for 5 years. I'm still waiting to get humbled so i can investing in the S&P500/bonds and call it a day. If history is any indicator, it should be an eventuality. But given the perspective that stone-age axes don't work against fighter jets, I wonder how that could come to pass.
fdsakjfsdfj 6y ago
It might interest some people here to know that if the EMH were true, you could use it to break unbreakable cryptography. However that's not what would happen. If you tried it, your crack would fail, and you would just end up proving experimentally that EMH isn't true. That would move the discussion to "is it true except if you test it in weird experiments though?" which is not an interesting point of debate: Obviously there are no market participants with infinite wisdom and processing ability who know all public news and factor it into every stock's price instantly at all times, and are perfect in their analysis. And have been since the dawn of markets, even before the Internet. it's totally obvious. Anyway here is a protocol you can use to demonstrate EMH is false, any time you want: https://arxiv.org/abs/1011.0423 https://arxiv.org/abs/1011.0423
- rahimnathwani 6y ago
  This is a fun paper, and the logic seems sound. But the contrived situation is nothing like real life, so it doesn't seem useful as a model.
mjfl 6y ago
It is trivial to outperform the market by insider trading, thus markets are inefficient. The efficient market hypothesis isn't dead, it was never true.
- perl4ever 6y ago
  I think empirically it's neither trivial nor impossible. For instance, say you are a CEO and earnings are about to be announced for your company. You know exactly what the earnings are going to be, and what the published expectations are, so you know how much they will beat or fall short. Does that mean you know how the market will react? I think people who have been in that position would tell you no. There was something in the news about someone who hacked into a database with earnings press releases that gave them access just a little early. And someone did an analysis of how reliably this worked to make money. It wasn't 100%!
  - mjfl 6y ago
    If you frontrun a merger or a huge earnings miss, there's nearly a 0 percent chance you will lose money, and you can further leverage with options.
littlestymaar 6y ago
The efficient market hypothesis has a really questionable name which is a recurrent source of confusion: it's not about markets being efficient (in terms of resources allocation), it's about the inability to efficiently forecast assets price. The former isn't necessary for the later to be true.
lend000 6y ago
The analogy I always use (similar to the joke about the economist not picking up a twenty dollar bill) is that the market is as efficient as an evolved jungle ecosystem. Most of us would consider this system highly efficient, certainly more so than one our government could design, but it doesn't mean an animal shouldn't be able to find food. It just means it requires energy to find it -- or, in the economy, to determine a more accurate future price. There's no free lunch.
xpe 6y ago
This is a clarification question (probably for people that have studied or read about the EMH in depth). Wikipedia's definition is: "The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information." The sentence above doesn't say how quickly the prices incorporate the information. The rest of the Wikipedia article didn't really clarify my core question (next). Could someone give a summary of how the EMH is or is not framed in terms of steady-state assumptions? In other words, does the core EMH theory concern itself with dynamics? (Random walk theory does discuss dynamics.) If there is a variation of theories that are all called "EMH", would you please summarize some grouping you find useful?
hash872 6y ago
How does the author explain the Renaissance Medallion Fund? Also (and I asked this in the last big HN discussion of EMH too), how can EMH co-exist with the existence of 'trading' as a profession? I don't mean day traders, I mean professional traders who work for Goldman Sachs, investments banks, etc. Every asset class in the world has dedicated, professional traders. If trading is fundamentally unprofitable over a long enough period of time.... why do sophisticated banks employ traders? (Wouldn't they, uh, have figured this out already?) Assuming trading is profitable (for professionals with a massive data advantage, etc.)- doesn't that disprove EMH? I can believe retail trading is always unprofitable, but why do the pros do it?
- tanvach 6y ago
  Hedge funds overall do not outperform index funds in the long run [1]. Banks have moved mostly to sell side and their traders earn commission and bid-ask spread. For a while the most profitable shops are market makers who use high-speed trading to leverage tiny arbitage opportunities, profiting exactly from tiny fluctuations from an efficient market. [1] http://ftalphaville.ft.com/2018/04/24/1524542401000/A-complex-analysis-reaches-same-conclusion-as-simple-one--hedge-funds-suck/z http://ftalphaville.ft.com/2018/04/24/1524542401000/A-comple...
  - hash872 6y ago
    >Hedge funds overall do not outperform index funds in the long run But the Medallion Fund does apparently, which is my point. How can they have 70+% returns year after year for decades in a world where EMH is true? Their existence seems to disprove it, no?
anm89 6y ago
Emh is almost tautologically ridiculous. Markets efficiently price the sums of everyones actions based on their opinions regarding the underlying facts. It doesn't price in some objective thing called "information". If one person takes one bet based on a piece of information and another person makes the opposite bet off of a differ wnt interpretation on the same piece of information then neither of their strongly held opinions altered the market price. If skewed numbers of people take those bets based on which side of the bed they woke up on then the market skews to that side. There isnt some conceptually perfect piece of "information" that is being priced here. Not everyone has the same information, and not everyone interprets the information the same way. All the market prices is the average of these subjective opinions, and sure it does that efficiently, but that does not mean that that price represents some perfect unbeatable truth. My bank account would also like to disagree with EMH
gonzo 6y ago
the efficient market hypotheis isn't dead, but markets are efficient only if P == NP https://arxiv.org/abs/1002.2284 https://arxiv.org/abs/1002.2284
- rahimnathwani 6y ago
  Someone posted a similar (but later) paper above: https://news.ycombinator.com/item?id=23371766 https://news.ycombinator.com/item?id=23371766
olliej 6y ago
This is nonsense, ignoring the social/human aspects of it, the "efficient market" hypothesis only works if competition is possible (e.g. no monopoly, minimal capital startup costs), and if P=NP.

61 points by jacobedawson 6y ago

I think there are two important aspects that make the EMH not a good predictor: - The markets move the prices themselves, so the prices are not the "canonical" ones (if there was ever such a thing) but it reflects the idea that the market itself has. Betting on a certain outcome in a game doesn't change the possible results, "betting on the market" does. So it's less about the "reality" and more about what the market thinks. The second aspect can be summed up by the phrase "one person is smart, but people are dumb" (with the added component of "the market can stay irrational longer than you can stay solvent") So, the market is probably not efficient but that doesn't mean you can beat it with ease.

mewpmewp2 6y ago

Finally some sense. I am so tired of people complaining about markets being irrational

greatwave1 6y ago

Here's a dashboard I made that tracks the performance of the average Robinhood user vs. the S&P 500 (using user holding data): https://www.quiverquant.com/sources/robinhood https://www.quiverquant.com/sources/robinhood There's an argument to be made that the ability to consistently UNDERPERFORM the market is evidence against the Efficient Market Hypothesis.

Natsu 6y ago
Alternatively, it means that someone has an edge that can be used to exploit RH (or maybe even all retail) investors. Given the state of the market, this seems ... disturbingly likely.
trader1 6y ago
Trading costs are a thing. In an efficient market I would expect ex-ante negative performance versus the benchmark.
- greatwave1 6y ago
  True, although the method I used to find the aggregate performance of Robinhood users ignored trading costs. Obviously this data is incredibly noisy and nowhere near statistically significant, but I like how it implies that betting against Robinhood traders would've been an alpha-generating strategy over the last two years.
  - trader1 6y ago
    I agree that the data is quite noisy, and the choice of weighting (by users instead of dollar value traded) may significantly influence results. Then again, after reading r/wallstreetbets, I am not so sure ;).
    - greatwave1 6y ago
      Yeah, unfortunately Robinhood doesn't provide data on # shares held per user. I've been doing something similar to track discussion on r/WSB here: https://www.quiverquant.com/wallstreetbets/ https://www.quiverquant.com/wallstreetbets/ I haven't finished any backtesting yet to see if they live up to their reputation haha.
- throw0101a 6y ago
  William F. Sharpe mentions this explicitly in "The Arithmetic of Active Management" (The Financial Analysts' Journal. January 1991, Vol. 47, Issue 1, Pages 7-9). He was a co-creator of CAPM (won Nobel) and did the Sharpe ratio: * https://en.wikipedia.org/wiki/William_F._Sharpe https://en.wikipedia.org/wiki/William_F._Sharpe
throw0101a 6y ago
Or it's all the sports fans not having any other way to spend their time: > They started betting on what color car would pass next * https://twitter.com/SportsCenter/status/1264026863367786496 https://twitter.com/SportsCenter/status/1264026863367786496
- ivalm 6y ago
  Sure, but part of EMH is that stocks are priced correctly, therefore in aggregate you would expect any sufficiently large collection of random portfolios should have the standard market return.
s1artibartfast 6y ago
That’s an interest question. What are the application for a rational actor in the EMH? Can application be reduced or applied to a subset of actors. What are the predictions for a random or misinformed actor in the market?
sukilot 6y ago
That chart shows Robinhood as randomly above and below S&P500

wizzwizz4 6y ago

A slightly different, more complete version by the same author can be found on LessWrong. It has some clarifying edits (written in small writing), and there's more discussion in the comments. https://www.lesswrong.com/posts/utySCY9nJt9xGYGGQ/the-emh-aten-t-dead https://www.lesswrong.com/posts/utySCY9nJt9xGYGGQ/the-emh-at...

deleted 6y ago
[deleted]

lisper 6y ago

For any big market movement you will always be able to find the person who acted on it first. That person will always look like a prescient genius if you just look at that one data point. To show a counterexample to the EMH you would need to exhibit someone who can consistently beat the market at odds better than chance under proper controlled conditions. No single data point can ever do it.

Retric 6y ago
The real problem with the EMH is most people consistently do worse than the market not better. In a completely efficient market every trade should be equivalent, but when you look at what happens when millions of the uniformed try and day trade they on average lose massive amounts of money. PS: I have tried to time the market exactly 4 times and it’s worked every time. That does not mean the EMH is dead, that’s just like how I am actually up on slot machines and have decided never to play again.
- lisper 6y ago
  Right. To show the EMH is dead you have to show that someone can beat the market with odds better than chance under properly controlled conditions. In a market with millions of participants, you would expect there to be a few who beat the market purely by luck many times in a row. In fact, in a population of a mere one million people, you would expect to find one person who beat the market 20 times in a row without a single miss by pure luck! Four for four is not even remotely remarkable. One person in every 16 will be able to do that.
  - RookyNumbas 6y ago
    Sure, that's all correct. But before showing it is dead it would be useful to have empirical evidence that it was ever alive. And the evidence is very mixed at best. The history of the EMH is a battle between those showing where it breaks from reality, followed by increasingly desperate attempts to save it with some additional explanatory factors. It's a nice model. But like most economic and financial models shouldn't be held as gospel.

zenlot 6y ago

EMH is dead.

vmception 6y ago

Efficient Market Theory is dead because it is unfalsifiable. It is not capable of being proved false, and should be discarded for that reason. Information asymmetries exist, not everyone with better information have the access to capital or risk profile to alter the market price of an asset.

s1artibartfast 6y ago
Does information or performance asymmetry disprove the theory?
- vmception 6y ago
  assets can be mispriced, efficient market theory requires stretching the logic to fit the theory. it requires a moving the goal post of to a longer and unspecific time frame to say that someone's outsized gains now are irrelevant, it requires moving the goal post to a greater unspecific amount of capital to say they can't beat the performance of the benchmark. anyone in any hard science will point out that the theory is unfalsifiable so pick a different theory. why are we making exceptions for economic and financial theories at all?
aaron695 6y ago
Your first two sentences are very interesting. > Information asymmetries exist, not everyone with better information have the access to capital or risk profile to alter the market price of an asset. This is talked about in the article and seems to just start an argument again and not explain the unfalsifiable statement.
- vmception 6y ago
  Sorry if that weakens the argument to you. It is a separate thought. My point is that "asset pricing" theories are too reductive, and should at least factor in undercapitalized people that do not wish to speculate that can perceive information. Or just abandon reductive asset pricing theories and focus on other things. Promote liquidity and increases in transactions, "efficiency" in that context, not "efficiency" in a "it already is and has been all the time and forever" context.

nickpinkston 6y ago

More interesting than "Is EMH dead?" is our improving understanding of the efficiency of incorporating new information into markets is getting better. I'll refer you below to Andrew Lo's "Adaptive Market Hypothesis" which: "is an attempt to reconcile economic theories based on the efficient market hypothesis (which implies that markets are efficient) with behavioral economics, by applying the principles of evolution to financial interactions: competition, adaptation and natural selection."[1] [1] https://en.wikipedia.org/wiki/Adaptive_market_hypothesis https://en.wikipedia.org/wiki/Adaptive_market_hypothesis

trader1 6y ago

The article reads like it was written by someone who has a deep interest in finance, but hasn't worked much in the industry. Markets are quite efficient, but there are pockets of risk premia driven by regulatory/intermediary constraints and plain old behavioral bias. Then again, if he knew about them, he presumably wouldn't write about them in an internet blog post.

arminiusreturns 6y ago

Money printer goes brrrrrr. Effecient markets!

ivalm 6y ago

One thing this blog doesn’t address is price elasticity/liquidity. There is far less friction and chance to get front-run if you are dealing with $100k rather than $100M.

erokar 6y ago

Markets are not rational, they exhibit crowd psychology and as such are more primitive and irrational than individual behavior. Quite a few professional traders, hedge funds and even retail traders consistently outperform the indexes. They are able to do this because they have recognized the fallacy of EMH and are able to exploit the market's irrationality.

throw0101a 6y ago
> Quite a few professional traders, hedge funds and even retail traders consistently outperform the indexes. In any one year there are a number of them do, but SPIVA has shown that over the course of 5, 10, and 15 years that number gets smaller and smaller: * https://us.spindices.com/spiva/#/ https://us.spindices.com/spiva/#/ Also: just because the market is not 100% efficient, and some folks can find 'weaknesses', does not mean it is not mostly efficient. * https://yourlogicalfallacyis.com/black-or-white https://yourlogicalfallacyis.com/black-or-white Not even Fama, whose is often credited for formulating the EMH, has said that it is 100: * https://en.wikipedia.org/wiki/Eugene_Fama https://en.wikipedia.org/wiki/Eugene_Fama
- throw0101a 6y ago
  Replying to myself on the SPIVA point (PDF): > Over the 15-year period ending June 2019, 90% of large-cap, midcap and small-cap funds underperformed their benchmark S&P indices. In only one asset class, large value (80% underperformed), was the percentage of underperformers below 86%. * https://www.advisorperspectives.com/articles/2019/11/18/the-surprising-results-from-s-ps-latest-spiva-analysis.pdf https://www.advisorperspectives.com/articles/2019/11/18/the-...
- ternaryoperator 6y ago
  I don't disagree with the point you're making, but I should point out that one reason some funds don't beat the S&P500 is because of the fees they charge, which are deducted from their performance. In reality, their actual gross performance is better than the S&P. However, the fact that the results are so close to the S&P's performance that the fees alone can push them below it supports your overarching point.

matthewdgreen 6y ago

This seems like a silly point. Are markets more efficient in the infinitely long run than an individual who tries to identify the "correct" price? Quite probably. Does the current stock market price at any given moment possibly reflect the herd mentality of a bunch of jumped-up plains apes (or the injection of a huge amount of funds by a central bank), rather than representing the future expected earnings of a given asset? Also extremely likely. The performance of the markets during the lead-up to the pandemic was absurd. It wasn't just the top-line market prices that were wrong: the obvious hedges, like Put options, were all massively mispriced, to the point that even banks started warning about it. This eventually corrected, but the correction itself was extremely painful. Now the Fed is injecting dollars in order to help "correct" the correction, with unknown long-term effects. (I don't know what the EMH has to say about prices under this regime.) Anyway, "the EMH is wrong" is an absurd simplification of the problem. The real objection here is that asset prices may be right on average, in the long-enough term, but are prone to huge over-confidence bubbles and corrections that can wreak havoc on the actual human beings, and possibly lead to suboptimal economic outcomes when prices are used to direct investment.

JumpCrisscross 6y ago
> obvious hedges, like Put options, were all massively mispriced As a former options market maker, this wasn’t obvious. That said, every time volatility snaps one tends to find a cohort of investors who got burned blaming the Fed.
rmrfstar 6y ago
EMH is a mental-model of equilibrium, and is useful when used that way. Financial systems have multiple equilibria [1], so EMH "violations" come in two flavors: 1. Small deviation from equilibrium. This is where Renaissance Technologies hangs out. 2. Market herd expects the wrong equilibrium. This is where Nassim Taleb hangs out. On the scale of single years, 2 happens so rarely than you can't get statistically significant measurements. So, we end up with endless philosophical debates about whether EMH is "true". [1] https://en.wikipedia.org/wiki/Diamond%E2%80%93Dybvig_model https://en.wikipedia.org/wiki/Diamond%E2%80%93Dybvig_model
6y ago

jkhdigital 6y ago

“The Market” is a leaky abstraction for the collective activity of millions of individual humans making concrete decisions at specific points in time. The EMH says something about the model, not about reality, so there will always be a gap.

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meesterdude 6y ago

First off, I don't like titles telling me what to do. You're not my real mom. Second, this was more incoherent babble than useful. While I am an investing nerd, this article could be about 1/3rd as long. The rest was trash writing and ego. Third, there is some worthwhile content in that 1/3rd that's good. But it's nothing groundbreaking or new, and detached from the EMH topic. His perspective on Warren Buffet was worthwhile, though, and the idea that once a tactic goes public the collective abosrbes it and the edge is lost is worth pondering over, and the comparison of using a stone-age axe against a fighter jet is meaningful too. There's no real discussion around the lifetime of tools, techniques, and perspectives. That might be the most worthwhile takeaway for me. Forthly, equating market action to coin tossing is intellectual laziness. I would agree with this on an intraday trading level, but in long term investing that's just not the behavior equities exhibit. Lastly, my portfolio has beat the S&P500 by significant margin (>3-8x) for 5 years. I'm still waiting to get humbled so i can investing in the S&P500/bonds and call it a day. If history is any indicator, it should be an eventuality. But given the perspective that stone-age axes don't work against fighter jets, I wonder how that could come to pass.

fdsakjfsdfj 6y ago

It might interest some people here to know that if the EMH were true, you could use it to break unbreakable cryptography. However that's not what would happen. If you tried it, your crack would fail, and you would just end up proving experimentally that EMH isn't true. That would move the discussion to "is it true except if you test it in weird experiments though?" which is not an interesting point of debate: Obviously there are no market participants with infinite wisdom and processing ability who know all public news and factor it into every stock's price instantly at all times, and are perfect in their analysis. And have been since the dawn of markets, even before the Internet. it's totally obvious. Anyway here is a protocol you can use to demonstrate EMH is false, any time you want: https://arxiv.org/abs/1011.0423 https://arxiv.org/abs/1011.0423

rahimnathwani 6y ago
This is a fun paper, and the logic seems sound. But the contrived situation is nothing like real life, so it doesn't seem useful as a model.

mjfl 6y ago

It is trivial to outperform the market by insider trading, thus markets are inefficient. The efficient market hypothesis isn't dead, it was never true.

perl4ever 6y ago
I think empirically it's neither trivial nor impossible. For instance, say you are a CEO and earnings are about to be announced for your company. You know exactly what the earnings are going to be, and what the published expectations are, so you know how much they will beat or fall short. Does that mean you know how the market will react? I think people who have been in that position would tell you no. There was something in the news about someone who hacked into a database with earnings press releases that gave them access just a little early. And someone did an analysis of how reliably this worked to make money. It wasn't 100%!
- mjfl 6y ago
  If you frontrun a merger or a huge earnings miss, there's nearly a 0 percent chance you will lose money, and you can further leverage with options.

littlestymaar 6y ago

The efficient market hypothesis has a really questionable name which is a recurrent source of confusion: it's not about markets being efficient (in terms of resources allocation), it's about the inability to efficiently forecast assets price. The former isn't necessary for the later to be true.

lend000 6y ago

The analogy I always use (similar to the joke about the economist not picking up a twenty dollar bill) is that the market is as efficient as an evolved jungle ecosystem. Most of us would consider this system highly efficient, certainly more so than one our government could design, but it doesn't mean an animal shouldn't be able to find food. It just means it requires energy to find it -- or, in the economy, to determine a more accurate future price. There's no free lunch.

xpe 6y ago

This is a clarification question (probably for people that have studied or read about the EMH in depth). Wikipedia's definition is: "The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information." The sentence above doesn't say how quickly the prices incorporate the information. The rest of the Wikipedia article didn't really clarify my core question (next). Could someone give a summary of how the EMH is or is not framed in terms of steady-state assumptions? In other words, does the core EMH theory concern itself with dynamics? (Random walk theory does discuss dynamics.) If there is a variation of theories that are all called "EMH", would you please summarize some grouping you find useful?

hash872 6y ago

How does the author explain the Renaissance Medallion Fund? Also (and I asked this in the last big HN discussion of EMH too), how can EMH co-exist with the existence of 'trading' as a profession? I don't mean day traders, I mean professional traders who work for Goldman Sachs, investments banks, etc. Every asset class in the world has dedicated, professional traders. If trading is fundamentally unprofitable over a long enough period of time.... why do sophisticated banks employ traders? (Wouldn't they, uh, have figured this out already?) Assuming trading is profitable (for professionals with a massive data advantage, etc.)- doesn't that disprove EMH? I can believe retail trading is always unprofitable, but why do the pros do it?

tanvach 6y ago
Hedge funds overall do not outperform index funds in the long run [1]. Banks have moved mostly to sell side and their traders earn commission and bid-ask spread. For a while the most profitable shops are market makers who use high-speed trading to leverage tiny arbitage opportunities, profiting exactly from tiny fluctuations from an efficient market. [1] http://ftalphaville.ft.com/2018/04/24/1524542401000/A-complex-analysis-reaches-same-conclusion-as-simple-one--hedge-funds-suck/z http://ftalphaville.ft.com/2018/04/24/1524542401000/A-comple...
- hash872 6y ago
  >Hedge funds overall do not outperform index funds in the long run But the Medallion Fund does apparently, which is my point. How can they have 70+% returns year after year for decades in a world where EMH is true? Their existence seems to disprove it, no?

anm89 6y ago

Emh is almost tautologically ridiculous. Markets efficiently price the sums of everyones actions based on their opinions regarding the underlying facts. It doesn't price in some objective thing called "information". If one person takes one bet based on a piece of information and another person makes the opposite bet off of a differ wnt interpretation on the same piece of information then neither of their strongly held opinions altered the market price. If skewed numbers of people take those bets based on which side of the bed they woke up on then the market skews to that side. There isnt some conceptually perfect piece of "information" that is being priced here. Not everyone has the same information, and not everyone interprets the information the same way. All the market prices is the average of these subjective opinions, and sure it does that efficiently, but that does not mean that that price represents some perfect unbeatable truth. My bank account would also like to disagree with EMH

gonzo 6y ago

the efficient market hypotheis isn't dead, but markets are efficient only if P == NP https://arxiv.org/abs/1002.2284 https://arxiv.org/abs/1002.2284

rahimnathwani 6y ago
Someone posted a similar (but later) paper above: https://news.ycombinator.com/item?id=23371766 https://news.ycombinator.com/item?id=23371766

olliej 6y ago

This is nonsense, ignoring the social/human aspects of it, the "efficient market" hypothesis only works if competition is possible (e.g. no monopoly, minimal capital startup costs), and if P=NP.