Thursday, March 11, 2010

Efficient markets and the Chicago school

Left: The Free Market Fairy insists, insists I say, that she (he?) really IS efficient.

Angry Bear asks, Why does anybody still listen to the Chicago school, given that its theories don't match reality? And Jazzbumpa asks, if the markets can veer up and down like a drunk driver based on incomplete information, how can anybody ever call them efficient?

My thoughts: I'm not sure that the efficient market theory has failed, as such. Rather, I think people have read their ideological wants and desires into efficient market theory.

There's nothing wrong with the core observation of the efficient market theory, which is that prices in a market tend to converge over time towards some value which can be presumed to be the "true" value of the commodity in question. The problem is that *OVER TIME* thing. In the long run, prices will converge... but in the long run we're all dead (i.e., the timeframe where it takes markets to settle on the price of a commodity may be longer than the timeframe in which economic fundamentals change). In that case the entire efficient markets theory involved is useless, because if conditions in the market change faster than prices can converge -- if new sources of a commodity arise, if new technology is invented to make something cheaper to build, if an economic recession caused by a temporary bubble in housing prices collapsing happens -- then the prices in fact never *will* converge on the price that efficient markets theory predicts.

The efficient markets advocates themselves will readily admit that prices converge over time as markets "discover" the value of the commodity, not immediately. Given how swiftly market conditions change in the real world, that in essence is an admission by the efficient markets advocates that their theory is not, in fact, useful under real world conditions. Good luck on getting any of them to admit that, though...

- Badtux the Economics Penguin


  1. Colorful paraphrse, but I really can't quibble with it.

    From Wikipedia, the source of all knowledge, we get (emphasis added): The weak version of EMH suppose that prices on traded assets (e.g., stocks, bonds, or property) already reflect all past publicly available information. The semi-strong version supposes that prices reflect all publicly available information and instantly change to reflect new information. The strong version supposes that market reflects even hidden/inside information. The theoretical validity of the weak version is equivalent one of the great open problems in computer science, where evidence indicates that it is likely false[1]. There is some disputed evidence to suggest that the semi-strong version may be valid while there is strong evidence against the strong version.

    In an unregulated world where generally accepted accounting principles are only slightly better than "I'll lie and you swear to it," some skepticism is warranted.

    Further, I'd say the Enron experience pretty much blows the whole damned thing away.

    EMH proposes market price adjustment within minutes, not over the time spans you are talking about.

    That requires a lot of wand waving.

    EMH and rational expectations are joined at the waste. People are at-best semi-rational beings ruled by emotions. The whole thing is wand-drippings.


  2. Three words: Motors Liquidation Company. Utterly worthless, its whole reason for being is to dispose of whatever pieces of the GM carcass were not wanted when GM was dumped. It is comprised of closed dealerships that aren't around anymore, bad debts that will never be paid, and empty name plates with no cars to go behind them. Yet still people trade its stock on the stock market at some price above $0...

    You rube MLC into the nose of the efficient markets advocates and the Free Market Fairy's wand starts waving (to wave it away) so fast that you hear a sonic boom... yet MLC still trades at a non-zero price despite being utterly worthless. Imagine that!

    -- Badtux the Snarky Penguin

  3. One big problem with the EMH (Efficient Markets Handjive) and Glibertarianism in general is that they do not take HUMAN CRIMINALITY into account.

    Sure, in HypotheticalWorld, prices might sort themselves out all legally and logically. But in RealWorld, when there's money to be made, games will be played. Like Goldscam Sacks' front-running "High Frequency Trading" in stocks. Criminals steal, despite what some theory says they should do.

    And when they can successfully buy the police force, as the bankmaggots have, the only limit to what they can steal is the total amount of money in the world. They're trying to gin up more of that money as fast as deflation can destroy it, and they might succeed. Or they might make the very concept of fiat money irrelevant, if they degrade it too much, too fast. (Which is why I like gold, but that's another story.) Anyway, the new money is not going to be given to the likes of you or me.

    Why do people pay attention to an economic theory that does not take reality into account? Because it allows them to pacify the average suckers with a fairy tale that seems all nice and shiny, like the fable of "American democracy." And the real insiders (see Goldscam) can use the theory as cover for their ripoffs.

    Works for them, sucks for us!

  4. Yeah, they talk about this beautiful free market fairy who magically waves her wand and presto chango, everything looks great. When actually the free market fairy is a grumpy tranny whose day job is kneecapping people for the Mob (or our ruling top 400 oligarchs who own more of America than the bottom 51% of Americans combined, whatever, same difference) and who would sooner whack you over the head with her (his?) magic wand than actually do anything for mere mortals like you and I. But people listen to these New Mobsters talking about how pretty that free market fairy is, and kids like us shout, "hey, youse! Your free market fairy has hairy legs and a beard!" and nobody listens.... sigh!

    - Badtux the Hairy Fairy Penguin


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