Efficient Market Hypothesis

[millionairemind]

Investors are finally seeing the nonsense in the efficient market theory
The best response I've heard to the efficient markets theory that has dominated thinking about investment for 30 years or more is a joke. Two men walking down a street spot a £20 note on the pavement. One, an economics professor, says to the other: "don't bother to pick it up – if it were really a £20 note it wouldn't be there".
http://www.telegraph.co.uk/finance/comm ... heory.html

[Musicwhiz]

Yeah MM I read that story too !

Guess what, the other day I was cycling and I spotted a S$10-bill (red colour, very obvious) lying on the ground. Needless to say, I picked it up immediately !

[financecaptain]

What is the probabilty that you would be the first or only one to spot $10 or $50 on a busy street ? Likelyhood it will be picked up very fast ... so in that sense EMH does stand.

[millionairemind]

At interesting article on this week's Economist on the demise of EMT

Jul 16th 2009 | NEW YORK
From The Economist print edition
The efficient-markets hypothesis has underpinned many of the financial industry’s models for years. After the crash, what remains of it?
http://www.economist.com/displaystory.c ... d=14030296

[kennynah]

i suppose in layman's term, to these bombastic words, "Efficient Market Theory", is quite simply...

There's No Such a Thing as Free Lunch....most often

[winston]

For those who are interested in reading up on the hypothesis ..

Efficient-market hypothesis
From Wikipedia, the free encyclopedia

In finance, the efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient", or that prices on traded assets (e.g., stocks, bonds, or property) already reflect all known information, and instantly change to reflect new information.

Therefore it is impossible to consistently outperform the market by using any information that the market already knows, except through luck. Information or news in the EMH is defined as anything that may affect prices that is unknowable in the present and thus appears randomly in the future.

http://en.wikipedia.org/wiki/Efficient- ... hypothesis

[winston]

Just read something called Adaptive Markets Hypothesis in this month's Bloomberg Magazine. After spending a two hours on it, I still cant find a practical application for it

========================================================

From Wikipedia:-

The Adaptive Market Hypothesis, as proposed by Andrew Lo (2004,2005), is a new framework that reconciles theories that imply that the markets are efficient with behavioral alternatives, by applying the principles of evolution - competition, adaptation, and natural selection - to financial interactions. [1]

Under this approach the traditional models of modern financial economics can coexist alongside behavioral models in an intellectually consistent manner. He argues that much of what behavioralists cite as counterexamples to economic rationality - loss aversion, overconfidence, overreaction, and other behavioral biases - are, in fact, consistent with an evolutionary model of individuals adapting to a changing environment using simple heuristics.

According to Lo, the Adaptive Markets Hypothesis can be viewed as a new version of the efficient market hypothesis, derived from evolutionary principles. "Prices reflect as much information as dictated by the combination of environmental conditions and the number and nature of "species" in the economy." By species, he means distinct groups of market participants, each behaving in a common manner (i.e. pension funds, retail investors, market makers, and hedge-fund managers, etc.).

If multiple members of a single group are competing for rather scarce resources within a single market, that market is likely to be highly efficient, e.g., the market for 10-Year US Treasury Notes, which reflects most relevant information very quickly indeed. If, on the other hand, a small number of species are competing for rather abundant resources in a given market, that market will be less efficient, e.g., the market for oil paintings from the Italian Renaissance.

Market efficiency cannot be evaluated in a vacuum, but is highly context-dependent and dynamic. Shortly stated, the degree of market efficiency is related to environmental factors characterizing market ecology such as the number of competitors in the market, the magnitude of profit opportunities available, and the adaptability of the market participants (Lo,2005).

Implications
The AMH has several implications that differentiate it from the EMH such as:
To the extent that a relation between risk and reward exists, it is unlikely to be stable over time.
Contrary to the classical EMH, arbitrage opportunities do exist from time to time.
Investment strategies will also wax and wane, performing well in certain environments and performing poorly in other environments. This includes quantitatively-, fundamentally- and technically-based methods.
Survival is the only objective that matters while profit and utility maximization are secondary relevant aspects
Innovation is the key to survival because as risk/reward relation varies through time, the better way of achieving a consistent level of expected returns is to adapt to changing market conditions.

http://en.wikipedia.org/wiki/Adaptive_market_hypothesis

[kennynah]

Just read something called Adaptive Markets Hypothesis in this month's Bloomberg Magazine. After spending a two hours on it, I still cant find a practical application for it

it could have been better spent at kopitiam, sipping kopi-o-kosong...watching the world go by...

[winston]

Six impossible things before breakfast, or how EMH has damaged our industry
The Dead Parrot of Finance
The Queen of Hearts and impossible beliefs
Slaves of some defunct economist
Prima facie case against EMH -- Forever blowing bubbles
The EMH 'Nuclear Bomb'

The Efficient Market Hypothesis, according to Shiller, is one of the most remarkable errors in the history of economic thought. EMH should be consigned to the dustbin of history. We need to stop teaching it, and brainwashing the innocent.

Rob Arnott tells a lovely story of a speech he was giving to some 200 finance professors. He asked how many of them taught EMH - pretty much everyone's hand was up. Then he asked how many of them believed it. Only two hands stayed up!

http://www.investorsinsight.com/blogs/t ... kfast.aspx

[millionairemind]

I was reading HOW WE DECIDE and there was a paragraph on Modern Portfolio Theory.

It mentioned that Harry Markowitz, who invented the MPT, couldn't bring himself to use his own equations when he had to allocate his own capital.

Those who can, do. Those who can't, dream up theories on why those who can, do