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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 app

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.

sudosysgen 2y ago
Actually, prices change far less than you would expect and more slowly than they should if they were to reflect information. See: https://en.wikipedia.org/wiki/Nominal_rigidity https://en.wikipedia.org/wiki/Nominal_rigidity 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.
- legitster 2y ago
  Rigidity is usually applied to common markets which everyone agrees are pretty inefficient. Efficient markets hypothesis was written specifically with stock markets and exchanges in mind, and it's what the linked article mostly discussed.
  - sudosysgen 2y ago
    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.
atoav 2y ago
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.
- nostrademons 2y ago
  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.

sudosysgen 2y ago

Actually, prices change far less than you would expect and more slowly than they should if they were to reflect information. See: https://en.wikipedia.org/wiki/Nominal_rigidity https://en.wikipedia.org/wiki/Nominal_rigidity 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.

legitster 2y ago
Rigidity is usually applied to common markets which everyone agrees are pretty inefficient. Efficient markets hypothesis was written specifically with stock markets and exchanges in mind, and it's what the linked article mostly discussed.
- sudosysgen 2y ago
  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.

atoav 2y ago

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.

nostrademons 2y ago
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.