http://www.ft.com/cms/s/0/40de18ee-5a0e-11de-b687-00144feabdc0.html?nclick_check=1
Sounds like an interesting article. Do you have the full article, perhaps you can post the entire article on here. I almost quit the CFA exam based on the EMT. I thought if markets are always efficiently and information is dissipated through market participants then prices should always reflect market value. However, one mans garbage is another mans treasure. The fact that market participants are irrational means that there are going to be opportunities to profit from market “exuberance” when wall street gets drunk. The art is to find these opportunities and recognize when market rationality is off balance.
EMT was never suppose to be a black and white issue There is a famous joke about two economists walking down the street. They spot a $20 note on the footpath. One starts to pick it up, but the other one says “Don’t bother; if the note was real someone would have picked it up already.” The joke highlights the lesson that an inflexible belief in efficient markets can paralyse investors and lead them to believe that no research effort can be justified. What the EMH proposes is that the markets are so competitive that only superior insight will earn money and that the easy pickings have already been picked. In the end it is likely that the value add that a professional manager can give to a portfolio over the long term (after fees, taxes and costs) is so small that statisticians will have trouble identifying it. .
^ Nice one Freo.
Why would you almost quit the CFA programme over EMT? There’s nothing that I’ve seen in the curriculum to suggest blind faith in it. Haven’t you got to the Traynor-Black bit yet?
Carson, The cornerstone of the CBOK is the EMH. All the models assume some sort of equilibrium and appraise various metrics according to the equilibrium benchmark, etc. It doesn’t advocate blind faith in it, but really never explores fully the case against it. Sort of how academics poo-poo great money managers as aberrational. I have a problem with a lot of the CBOK but it all really boils down to the CFA answer on the exam. Like cpatel mentioned, the more people who blindly believe in this - the more opportunities for individuals who don’t.
Carson, EMT has been mentioned in the curriculum, but in the interest of investigation I researched it above and beyond the requirement of the CFA. Based on this theory mainly from a lot of academics and the evidence of sub par performance of actively managed funds available to the general public that prices reflect, at all times the assumptions and risks of future performance made available by public information. The theory hypothesizes that information is dissipated throughout the markets. One would then question that if the competitiveness of the markets are such that any new information is translated into prices instantly. If this is the case then it would be very difficult to achieve alpha. One of the major assumptions of this theory is that all investors are rational, that they make their investment decisions based on a consistent, linear methodology universally accepted and used throughout the market. We all know that this is not the case, thus the EMT will always remain a theory.
To assert markets are irrational or inefficient, one needs to propose a measure of “true value”, and then show that actual market prices diverge from this. Any test of market efficiency is a joint test of a market model and the concept of efficiency. It is essential to have a specific alternative, because how do you know they are wrong unless you know the right answer? With hindsight, prices that were once really high, now not,were wrong, but one has to be able to go back in time and show the then-consensus was obviously wrong. Thus, if you propose, say, some metric of P/E, or dividend payout ratios, that is fine, but then there will be some range of P/Es that, when breached, generate inevitable mean-reversion thus demonstrating the correctness of the P/E ratio. A rational market should move a lot as people change their estimation. If you want to call it ‘irrational’, me ‘rational’, I think we can agree to disagree, but note it’s all semantics. I think many people think ‘rational’ means ‘correct’, I think, in EMH rational means ‘reasonable’ as defined by good-faith, educated and intelligent humans, fallible as we are.
I am with Colonel.
Then you are with Taleb, since the Colonel just copied that first paragraph straight out of Fooled by Randomness without attributing its source.
tobias Wrote: ------------------------------------------------------- > Then you are with Taleb, since the Colonel just > copied that first paragraph straight out of Fooled > by Randomness without attributing its source. So be it.
“Investors” in general being rational is not a requisite of the EMH holding – irrationalities can exist, as long as those that are rational are keeping the irrational in check. And as Burton M. says in A Random Walk Down Wall St, even if investors and markets are irrational at times, there is no way to predict their irrationality – when it will happen, and for how long. Imagine going short tech stocks in 1994 – you’d be toast. Also, as L2 and L3ers will know, Treynor-Black is a framework for allocating between an active and passive portfolio. The interesting thing is, markets appear so obviously inefficient so often, yet professional money managers so regularly and consistently underperform passive investing. There are outliers, but they are just that. So we can believe that investors are not rational, that markets are not efficient, and still realize that you cannot outperform the averages.
tobias Wrote: ------------------------------------------------------- > Then you are with Taleb, since the Colonel just > copied that first paragraph straight out of Fooled > by Randomness without attributing its source. The first paragraph where? The Prologue, Solon’s Warning, Nero Tulip? I might have sounded like Taleb but I don’t see where I copied it.
I believe in Extended CAPM. Thank you for this wonderful theory I now apply daily!
Colonel Mustard Wrote: ------------------------------------------------------- > tobias Wrote: > -------------------------------------------------- > ----- > > Then you are with Taleb, since the Colonel just > > copied that first paragraph straight out of > Fooled > > by Randomness without attributing its source. > > > The first paragraph where? The Prologue, Solon’s > Warning, Nero Tulip? I might have sounded like > Taleb but I don’t see where I copied it. Are you Eric Falkenstein?
Ahh, apologies, Colonel. I was referring to your first paragraph, not Taleb’s, but it turns out I was mistaken. I am currently reading Fooled by Randomness and knew I had read the equivalent of your first paragraph somewhere recently, and assumed it was the book. In fact, I read it here: http://falkenblog.blogspot.com/2009/06/do-crashes-support-or-disprove-rational.html So are you Eric Falkenstein or did you plagiarize HIS work? Because every single word from the first paragraph of your post is word-for-word straight out of his blog post. From the link above: To assert markets are irrational or inefficient, however, one needs to propose a measure of ‘true value’, and then show that actual market prices diverge from this. As classically worded by economists, any test of market efficiency is a joint test of a market model and the concept of efficiency. Thus, your test may merely be rejecting your market model, not efficiency. You may think this is unfair, but it’s simple logic, and you have to deal with it. It is essential to have a specific alternative, because how do you know they are wrong unless you know the right answer? With hindsight, prices that were once really high, now not, were ‘wrong’, but one has to be able to go back in time and show the then-consensus was obviously wrong. Thus, if you propose, say, some metric of P/E, or dividend payout ratios, that is fine, but then presumably there will be some range of P/Es that, when breached, generate inevitable mean-reversion thus demonstrating the correctness of the P/E ratio. Actual arbitrage, in the form of strategies that generate attractive Sharpe ratios, are necessary, and this is very hard to do. A rational market should move a lot as people change their estimation that, say, the next Microsoft is extant in a set of internet stocks (with potential future market cap of $200B), or that a worldwide Depression is likely.
oops, meant to include this for side-by-side comparison Colonel Mustard Wrote: ------------------------------------------------------- > To assert markets are irrational or inefficient, > one needs to propose a measure of “true value”, > and then show that actual market prices diverge > from this. Any test of market efficiency is a > joint test of a market model and the concept of > efficiency. It is essential to have a specific > alternative, because how do you know they are > wrong unless you know the right answer? With > hindsight, prices that were once really high, now > not,were wrong, but one has to be able to go back > in time and show the then-consensus was obviously > wrong. Thus, if you propose, say, some metric of > P/E, or dividend payout ratios, that is fine, but > then there will be some range of P/Es that, when > breached, generate inevitable mean-reversion thus > demonstrating the correctness of the P/E ratio. A > rational market should move a lot as people change > their estimation. > > If you want to call it ‘irrational’, me > ‘rational’, I think we can agree to disagree, but > note it’s all semantics. I think many people think > ‘rational’ means ‘correct’, I think, in EMH > rational means ‘reasonable’ as defined by > good-faith, educated and intelligent humans, > fallible as we are.
Did anyone see James Montier’s new piece which came out this afternoon U.S. time? Any thoughts?