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Markets are obviously not efficient. The proof is trivial. Have you ever made a mistake? Congrats, that’s your proof. The market is a collection of people makin

Markets are obviously not efficient. The proof is trivial. Have you ever made a mistake? Congrats, that’s your proof. The market is a collection of people making decisions. People are capable of mistakes. People en masses are still people, and just as fallible, if not more. Thus, markets can and constantly do misprice things/inefficiently allocate capital. These real events are incompatible with perfectly efficient markets: * tulips * Bitcoin * google (billion dollar startups) * crashes * theranos * salem witch hunts that’s not to say markets are perfectly inefficient either. But they’re clearly fallible and imperfect. They clearly misinterpret available information all the time, even though they easily could’ve interpreted it correctly. Markets are full of emotion driven irrational actors, not Bayesian robotic egoless predictors, even though we like to pretend we’re the latter sometimes.

ashtonkem 6y ago
It’s kind of amazing in retrospect that “the markets are efficient” was a position leading up to 2008 that didn’t get you laughed out of the room. Nowadays we know that markets aren’t perfectly efficient, 2008 was quite the instruction, and we can now have a serious discussion about degrees of efficiency and inefficiency that the markets achieve.
- quixoticelixer- 6y ago
  Actually markets are efficient, they just aren't maximally efficient.
  - kohlerm 6y ago
    That is like saying that Bubblesort is efficent because it is more efficient than https://en.wikipedia.org/wiki/Bogosort https://en.wikipedia.org/wiki/Bogosort :-) Unless you come up with an upper bound of efficiency loss your statement is IMHO pretty meaningless.
- nlitened 6y ago
  Wasn’t 2008 crisis due to excessive risk-taking by government-backed banks? I doubt it is an “instruction” on markets efficiency — yes, if a government puts a lot of tax and newly-printed money in ponzi-schemes, bad things will happen.
- YZF 6y ago
  That's not the definition of an efficient market though. An efficient market isn't a guarantee of a correct price. It just means the known information is reflected in the price: "The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information." 2008 is not a contradiction and the other examples by the parent aren't contradictions either.
  - philosopher1234 6y ago
    This is a misinterpretation of what is meant by the efficient market hypothesis. "a hypothesis that states that share prices reflect all information and consistent alpha generation is impossible". What they're saying is that the market correctly sets share prices based on available information. To say that the market is considering available information is tautological and not interesting. The EMH as its popularly understood is not just "the market considers information" (again, not an interesting claim) but "the market considers all information and synthesizes it correctly" which is deflating to hopeful investors and trivially false. My examples are contradictions to this hypothesis.
    - YZF 6y ago
      The point is that you can not beat the market with your interpretation of the available information. This is not a question of the correctness of any given interpretation. Correctness can never be determined, there is no "correct" or "incorrect" interpretation of the available information. EDIT: So one thing to consider is that markets are predictive. A "correct" interpretation is only correct if it can predict what will happen in the future. And because the future is not predictable (proof needed but whatever) there is no way to know which interpretation is "correct".
      - philosopher1234 6y ago
        But this is also obviously false. Markets are subject to human phenomena, like mob mentality, which is the theme of the examples I listed. The same way fantastic tennis players can consistently outperform the rest of the competition, fantastic traders can certainly outperform others. Of course, in an ultra competitive environment, with a massive number of constant competitors, its very hard to retain a number one spot. Its also hard to predict markets because of the very fact that they're inefficient and irrational. There are so many active participants its hard to predict how they will react to available information. Take 2008 for instance. There was public information demonstrating fatal weakness in the housing market, but it was neglected en masse. This makes it very hard to beat the market. Even if you're correct, the market could decide to ignore the facts, and you wouldn't be able to reap any alpha from your observation.
- im3w1l 6y ago
  I have a competing hypothesis. "Efficiently inefficient markets hypythesis". It says that alpha is possible, but that it takes a lot of work and smarts and that you may be better off working your dayjob than trying to beat the market unless you have comparative advantages.
  - imtringued 6y ago
    The thing is that there is a limited of value that the market generates. Like producing half a million tons of steel or something. If you extract more value than the market generates then you have to take that value from someone else who made a mistake. Therefore maximum upside by "beating the market" is limited by the amount of mistakes other people are making and that upside is much smaller than you get from simply taking market returns.
- jokethrowaway 6y ago
  I think we're arguing semantics. Markets are obviously more efficient than a single investor or you would be able to beat the market with public information. And when you're able to beat the market you're making it more efficient. It's easy for politicians to blame 2008 on the markets, but I think it was caused by Keynesian government policies. I assume we'll have similar problems soon with all the stimuli being granted.
rajansaini 6y ago
I didn't read the full paper carefully, but does this mean P != NP? :)
- jsharf 6y ago
  lol
  - philosopher1234 6y ago
    we did it reddit
- Dylan16807 6y ago
  The paper blatantly lies about proving that if P=NP, then markets are efficient. It actually argues that if P=NP, and Moore's law continues indefinitely, then eventually someone could build an efficient market.
  - whatshisface 6y ago
    If Moore's law continues indefinitely, then we will climb the 2^n NP problem cost with a 2^t computer speed, which means that any specific NP-hard problem will become solvable in an amount of time linear in n.
    - Dylan16807 6y ago
      However the number of stock data points goes up over time, making it more like 2^(n*t) cost.
nyellin 6y ago
I agree with your examples and I agree that markets aren't efficient, but the "proof" you present is invalid because individual investors could be inefficient yet that doesn't mean that in aggregate markets are inefficient. (Informally, this reminds me of the central limit theorem.)
- Dylan16807 6y ago
  The central limit theorem doesn't get you close enough to perfect efficiency to distinguish between P and NP.
- philosopher1234 6y ago
  I agree with your logic. To self-interpret: I think my rationale demonstrates that the claim "markets are inefficient" is coherent, and my examples demonstrate that its true.
anm89 6y ago
Right. The idea that anybody takes efficient markets seriously is outlandish. Another simple proof is that not everybody bets on the market for every opinion they have but the market only prices info if you act in the market.
jl6 6y ago
But your proof also works against any system that involves people (i.e. all of them), so is the real question whether markets are as efficient as possible given the constraints of having to use fallible people?
- petrocrat 6y ago
  The word market loses all meaning without people. Markets are inherently a trade relationship between people.
roenxi 6y ago
I almost totally agree, and want to add a related observation - it isn't so much that the market is efficient (it isn't) but that anyone who makes the market more significantly more efficient will become very wealthy. So the market has big incentives to move towards efficiency.
- philosopher1234 6y ago
  This is interesting to me. It makes me wonder "are there cases where someone made the market more efficient and was not made very wealthy?" I think you're right that there is a massive incentive for the market to be more efficient, but I suspect there are cases where people were able to develop alpha without being able to capitalize on it, because the market denied or neglected the insight. Were there free markets in the 17th century, would they have been able to incorporate Galileo's insight? Or would they have joined the church in denunciation? Part of me thinks that if they did eventually come around to the solar system, it wouldn't be all that quick.
  - orhmeh09 6y ago
    Did Jonas Salk make the market more efficient?
- brigandish 6y ago
  Perhaps, but the Google anti-trust suit would seem a timely contradiction too. Monopolies are incentivised to keep the market inefficient (or roughly as efficient as it is) because change jeopardises their dominant position.
  - imtringued 6y ago
    A monopoly is not a market. One person is not a group.
    - brigandish 6y ago
      A monopoloy dominates a market but you are welcome to ignore that.
olalonde 6y ago
> Markets are obviously not efficient. The proof is trivial. Have you ever made a mistake? Congrats, that’s your proof. The problem with your comment (and this paper) is that it misrepresents what economists mean when they talk about the EMH. A more widely accepted interpretation of the EMH is just that it's impossible to reliably predict asset prices, or colloquially "beat the market", and it has a lot of evidence going for it (e.g. the poor track record of professional traders and fund managers over long periods of time).
- DiogenesKynikos 6y ago
  That version is also obviously wrong. It is possible for individual people to more correctly analyze the value of an asset than the stock market. People who looked carefully into the mortgages underlying mortgage-backed securities during the housing bubble (e.g., Michael Burry) are a good example of this. They clearly were not right "by accident" - they were right because they carefully analyzed the underlying assets, at a time when most people were not doing so. In order to make the EMH plausible, you have to restrict it so much that it's essentially meaningless: something on the order of, "If you take the ensemble of market players, they do not beat the market on average." But it's clear that individual market players do often better understand the value of particular assets than the market, and not just because they're lucky, but because they just do better analysis than the crowd does.
  - thekyle 6y ago
    This doesn't prove the EMH wrong. In order to prove EMH is wrong you need to show someone like Michael Burry can consistently outperform the market using only publically available information. Making one good trade (no matter how large) isn't that. In fact, following your reasoning every trade would invalidate the EMH. If the price goes up afterward then the buyer was "right" and if the price goes down afterward then the seller was "right".
    - DiogenesKynikos 6y ago
      One trade is enough, if the reason for that trade is something other than dumb luck. The idea behind demanding consistency is that you can get lucky with one trade, but that over the long run, your luck will average out, and your true ability will show. The EMH says that your true ability to judge value won't be greater than the market's ability to judge value. But there are cases where it's clear that the trade wasn't merely luck. That's why I gave the example of the housing bubble: people using only public information were able to better judge the value of MBSs, and it wasn't just luck. They were objectively smarter than the market, because they did something that most people weren't doing: they analyzed the underlying assets. Put another way, the market can behave irrationally, and can seriously mis-price assets. In fact, it often does so, and the reason is not simply that there's missing information. The reason is that people are irrational, lazy, hubristic, etc. > In fact, following your reasoning every trade would invalidate the EMH. No, only trades in which the person making the right call was right by something other than luck. The strongest version of the EMH that actually holds is probably something on the order of, "If you pick a random investor, their expected returns are the same as those of the broader market." That is, you have to weaken it until it's trivially correct.
imtringued 6y ago
You're talking about real world markets which are obviously not efficient by theoretical standards. They are not efficient the same way a physical ball is not spherical compared to a mathematical sphere.
- WJW 6y ago
  Of course there are some errors in real life. The more interesting question is how far from optimality the markets are. To carry on your analogy, a tennis ball is not perfectly spherical but it is round enough for practical use. Similarly, the market can be 99.99% efficient, in which case it's obviously not entirely perfect but close enough that the average citizen is extremely unlikely to find any real arbitrages (which is what the EMH is essentially about).
refurb 6y ago
I'm going to throw this out there as an idea (it's probably not new) - I would argue the markets are efficient on a long enough time scale. Yes, stock prices don't always instantaneously reflect true value, but on a long enough time scale, months to years, they do. The time scale is usually dependent on the transparency of the company's financials to investors. For public companies, the time scale is measured in quarters. For private companies, it could be measured in years or decades. And this actually lines up with the EMH - stock prices reflects all available information. Nothing about the hypothesis says it reflects the true value when key information is unavailable (e.g. fraud or a private company that doesn't open their books).
mellavora 6y ago
As a fan of the EMH.. It is a model. All models are wrong. Some are useful. The EMH is very useful. For example, a good understanding of its failure modes can lead to opportunities for profit. You list a few potential failure modes. or an understanding that "efficiency" depends on diffusion of information, thus when information has uneven diffusion times-- an efficient market still allows for information-diffusion arbitrage.

ashtonkem 6y ago

It’s kind of amazing in retrospect that “the markets are efficient” was a position leading up to 2008 that didn’t get you laughed out of the room. Nowadays we know that markets aren’t perfectly efficient, 2008 was quite the instruction, and we can now have a serious discussion about degrees of efficiency and inefficiency that the markets achieve.

quixoticelixer- 6y ago
Actually markets are efficient, they just aren't maximally efficient.
- kohlerm 6y ago
  That is like saying that Bubblesort is efficent because it is more efficient than https://en.wikipedia.org/wiki/Bogosort https://en.wikipedia.org/wiki/Bogosort :-) Unless you come up with an upper bound of efficiency loss your statement is IMHO pretty meaningless.
nlitened 6y ago
Wasn’t 2008 crisis due to excessive risk-taking by government-backed banks? I doubt it is an “instruction” on markets efficiency — yes, if a government puts a lot of tax and newly-printed money in ponzi-schemes, bad things will happen.
YZF 6y ago
That's not the definition of an efficient market though. An efficient market isn't a guarantee of a correct price. It just means the known information is reflected in the price: "The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information." 2008 is not a contradiction and the other examples by the parent aren't contradictions either.
- philosopher1234 6y ago
  This is a misinterpretation of what is meant by the efficient market hypothesis. "a hypothesis that states that share prices reflect all information and consistent alpha generation is impossible". What they're saying is that the market correctly sets share prices based on available information. To say that the market is considering available information is tautological and not interesting. The EMH as its popularly understood is not just "the market considers information" (again, not an interesting claim) but "the market considers all information and synthesizes it correctly" which is deflating to hopeful investors and trivially false. My examples are contradictions to this hypothesis.
  - YZF 6y ago
    The point is that you can not beat the market with your interpretation of the available information. This is not a question of the correctness of any given interpretation. Correctness can never be determined, there is no "correct" or "incorrect" interpretation of the available information. EDIT: So one thing to consider is that markets are predictive. A "correct" interpretation is only correct if it can predict what will happen in the future. And because the future is not predictable (proof needed but whatever) there is no way to know which interpretation is "correct".
    - philosopher1234 6y ago
      But this is also obviously false. Markets are subject to human phenomena, like mob mentality, which is the theme of the examples I listed. The same way fantastic tennis players can consistently outperform the rest of the competition, fantastic traders can certainly outperform others. Of course, in an ultra competitive environment, with a massive number of constant competitors, its very hard to retain a number one spot. Its also hard to predict markets because of the very fact that they're inefficient and irrational. There are so many active participants its hard to predict how they will react to available information. Take 2008 for instance. There was public information demonstrating fatal weakness in the housing market, but it was neglected en masse. This makes it very hard to beat the market. Even if you're correct, the market could decide to ignore the facts, and you wouldn't be able to reap any alpha from your observation.
im3w1l 6y ago
I have a competing hypothesis. "Efficiently inefficient markets hypythesis". It says that alpha is possible, but that it takes a lot of work and smarts and that you may be better off working your dayjob than trying to beat the market unless you have comparative advantages.
- imtringued 6y ago
  The thing is that there is a limited of value that the market generates. Like producing half a million tons of steel or something. If you extract more value than the market generates then you have to take that value from someone else who made a mistake. Therefore maximum upside by "beating the market" is limited by the amount of mistakes other people are making and that upside is much smaller than you get from simply taking market returns.
jokethrowaway 6y ago
I think we're arguing semantics. Markets are obviously more efficient than a single investor or you would be able to beat the market with public information. And when you're able to beat the market you're making it more efficient. It's easy for politicians to blame 2008 on the markets, but I think it was caused by Keynesian government policies. I assume we'll have similar problems soon with all the stimuli being granted.

rajansaini 6y ago

I didn't read the full paper carefully, but does this mean P != NP? :)

jsharf 6y ago
lol
- philosopher1234 6y ago
  we did it reddit
Dylan16807 6y ago
The paper blatantly lies about proving that if P=NP, then markets are efficient. It actually argues that if P=NP, and Moore's law continues indefinitely, then eventually someone could build an efficient market.
- whatshisface 6y ago
  If Moore's law continues indefinitely, then we will climb the 2^n NP problem cost with a 2^t computer speed, which means that any specific NP-hard problem will become solvable in an amount of time linear in n.
  - Dylan16807 6y ago
    However the number of stock data points goes up over time, making it more like 2^(n*t) cost.

nyellin 6y ago

I agree with your examples and I agree that markets aren't efficient, but the "proof" you present is invalid because individual investors could be inefficient yet that doesn't mean that in aggregate markets are inefficient. (Informally, this reminds me of the central limit theorem.)

Dylan16807 6y ago
The central limit theorem doesn't get you close enough to perfect efficiency to distinguish between P and NP.
philosopher1234 6y ago
I agree with your logic. To self-interpret: I think my rationale demonstrates that the claim "markets are inefficient" is coherent, and my examples demonstrate that its true.

anm89 6y ago

Right. The idea that anybody takes efficient markets seriously is outlandish. Another simple proof is that not everybody bets on the market for every opinion they have but the market only prices info if you act in the market.

jl6 6y ago

But your proof also works against any system that involves people (i.e. all of them), so is the real question whether markets are as efficient as possible given the constraints of having to use fallible people?

petrocrat 6y ago
The word market loses all meaning without people. Markets are inherently a trade relationship between people.

roenxi 6y ago

I almost totally agree, and want to add a related observation - it isn't so much that the market is efficient (it isn't) but that anyone who makes the market more significantly more efficient will become very wealthy. So the market has big incentives to move towards efficiency.

philosopher1234 6y ago
This is interesting to me. It makes me wonder "are there cases where someone made the market more efficient and was not made very wealthy?" I think you're right that there is a massive incentive for the market to be more efficient, but I suspect there are cases where people were able to develop alpha without being able to capitalize on it, because the market denied or neglected the insight. Were there free markets in the 17th century, would they have been able to incorporate Galileo's insight? Or would they have joined the church in denunciation? Part of me thinks that if they did eventually come around to the solar system, it wouldn't be all that quick.
- orhmeh09 6y ago
  Did Jonas Salk make the market more efficient?
brigandish 6y ago
Perhaps, but the Google anti-trust suit would seem a timely contradiction too. Monopolies are incentivised to keep the market inefficient (or roughly as efficient as it is) because change jeopardises their dominant position.
- imtringued 6y ago
  A monopoly is not a market. One person is not a group.
  - brigandish 6y ago
    A monopoloy dominates a market but you are welcome to ignore that.

olalonde 6y ago

> Markets are obviously not efficient. The proof is trivial. Have you ever made a mistake? Congrats, that’s your proof. The problem with your comment (and this paper) is that it misrepresents what economists mean when they talk about the EMH. A more widely accepted interpretation of the EMH is just that it's impossible to reliably predict asset prices, or colloquially "beat the market", and it has a lot of evidence going for it (e.g. the poor track record of professional traders and fund managers over long periods of time).

DiogenesKynikos 6y ago
That version is also obviously wrong. It is possible for individual people to more correctly analyze the value of an asset than the stock market. People who looked carefully into the mortgages underlying mortgage-backed securities during the housing bubble (e.g., Michael Burry) are a good example of this. They clearly were not right "by accident" - they were right because they carefully analyzed the underlying assets, at a time when most people were not doing so. In order to make the EMH plausible, you have to restrict it so much that it's essentially meaningless: something on the order of, "If you take the ensemble of market players, they do not beat the market on average." But it's clear that individual market players do often better understand the value of particular assets than the market, and not just because they're lucky, but because they just do better analysis than the crowd does.
- thekyle 6y ago
  This doesn't prove the EMH wrong. In order to prove EMH is wrong you need to show someone like Michael Burry can consistently outperform the market using only publically available information. Making one good trade (no matter how large) isn't that. In fact, following your reasoning every trade would invalidate the EMH. If the price goes up afterward then the buyer was "right" and if the price goes down afterward then the seller was "right".
  - DiogenesKynikos 6y ago
    One trade is enough, if the reason for that trade is something other than dumb luck. The idea behind demanding consistency is that you can get lucky with one trade, but that over the long run, your luck will average out, and your true ability will show. The EMH says that your true ability to judge value won't be greater than the market's ability to judge value. But there are cases where it's clear that the trade wasn't merely luck. That's why I gave the example of the housing bubble: people using only public information were able to better judge the value of MBSs, and it wasn't just luck. They were objectively smarter than the market, because they did something that most people weren't doing: they analyzed the underlying assets. Put another way, the market can behave irrationally, and can seriously mis-price assets. In fact, it often does so, and the reason is not simply that there's missing information. The reason is that people are irrational, lazy, hubristic, etc. > In fact, following your reasoning every trade would invalidate the EMH. No, only trades in which the person making the right call was right by something other than luck. The strongest version of the EMH that actually holds is probably something on the order of, "If you pick a random investor, their expected returns are the same as those of the broader market." That is, you have to weaken it until it's trivially correct.

imtringued 6y ago

You're talking about real world markets which are obviously not efficient by theoretical standards. They are not efficient the same way a physical ball is not spherical compared to a mathematical sphere.

WJW 6y ago
Of course there are some errors in real life. The more interesting question is how far from optimality the markets are. To carry on your analogy, a tennis ball is not perfectly spherical but it is round enough for practical use. Similarly, the market can be 99.99% efficient, in which case it's obviously not entirely perfect but close enough that the average citizen is extremely unlikely to find any real arbitrages (which is what the EMH is essentially about).

refurb 6y ago

I'm going to throw this out there as an idea (it's probably not new) - I would argue the markets are efficient on a long enough time scale. Yes, stock prices don't always instantaneously reflect true value, but on a long enough time scale, months to years, they do. The time scale is usually dependent on the transparency of the company's financials to investors. For public companies, the time scale is measured in quarters. For private companies, it could be measured in years or decades. And this actually lines up with the EMH - stock prices reflects all available information. Nothing about the hypothesis says it reflects the true value when key information is unavailable (e.g. fraud or a private company that doesn't open their books).

mellavora 6y ago

As a fan of the EMH.. It is a model. All models are wrong. Some are useful. The EMH is very useful. For example, a good understanding of its failure modes can lead to opportunities for profit. You list a few potential failure modes. or an understanding that "efficiency" depends on diffusion of information, thus when information has uneven diffusion times-- an efficient market still allows for information-diffusion arbitrage.