Paper about market inefficiency

Would love to hear all your thoughts on this… http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1306523 This article provides conclusive evidence that the U.S. stock market is highly inefficient. Our results, spanning a 45 year period, indicate dramatic, consistent, and negative payoffs to measures of risk, positive payoffs to measures of current profitability, positive payoffs to measures of cheapness, positive payoffs to momentum in stock return, and negative payoffs to recent stock performance. Our comprehensive expected return factor model successfully predicts future return, out of sample, in each of the forty-five years covered by our study save one. Stunningly, the ten percent of stocks with highest expected return, in aggregate, are low risk and highly profitable, with positive trends in profitability. They are cheap relative to current earnings, cash flow, sales, and dividends. They have relatively large market capitalization and positive price momentum over the previous year. The ten percent with lowest expected return (decile 1) have exactly the opposite profile, and we find a smooth transition in the profiles as we go from 1 through 10. We split the whole 45-year time period into five sub-periods, and find that the relative profiles hold over all periods. Undeniably, the highest expected return stocks are, collectively, highly attractive; the lowest expected return stocks are very scary - results fatal to the efficient market hypothesis. While this evidence is consistent with risk loving in the cross-section, we also present strong evidence consistent with risk aversion in the market aggregate’s longitudinal behavior. These behaviors cannot simultaneously exist in an efficient market.

How’s this for efficiency; I had a 45 minute conversation with an equity trader that had 3 losing days over 6 years. I also traded 6 feet away from another guy that never had a losing month in 9 years…I know i’ve only gone through level 1 material, but market efficiency made no reference to the time factor in edges, which is huge!

spreads Wrote: ------------------------------------------------------- > How’s this for efficiency; I had a 45 minute > conversation with an equity trader that had 3 > losing days over 6 years. I would have to see proof that he wasn’t full of crap, I’d also have to know what strategy he was trading (is he brokering, creating some sort of portable hedged alpha (no beta risk), etc?) > I also traded 6 feet > away from another guy that never had a losing > month in 9 years…I know i’ve only gone through > level 1 material, but market efficiency made no > reference to the time factor in edges, which is > huge! Again, I’d have to see proof and have the same answers as above.

I saved the paper and will read it when I get a chance. I know all of AF will be waiting for my review.

@Black Swan - I believe it. Read the quarterlies from GS, JPM, et al. You could count the number of days GS traders lost money on one hand. Granted that’s all the traders combined, but you don’t have only three losing days a year if your traders aren’t positive day in, day out.

Sweep the Leg, statically, it makes a HUGE difference aggregate vs individual. To have an individual show that level of stability in a prop trading environment is unheard of. This is why GS has so many traders to avg across. Also, many of those traders are market making, which is significantly different from true prop activities.

Or it could be that the markets are just that rigged.

Or that GS is rigged.

Black Swan Wrote: ------------------------------------------------------- > Sweep the Leg, statically, it makes a HUGE > difference aggregate vs individual. To have an > individual show that level of stability in a prop > trading environment is unheard of. This is why GS > has so many traders to avg across. Also, many of > those traders are market making, which is > significantly different from true prop activities. I don’t require proof from the former because his edge was based off a similar strategy from the guy I sat beside. He was a engineer and his strategy was automated among up to hundreds of stocks, hence the consistency. The period in question ended in 2006, and for anyone familiar with the past specialist NYSE market structure, you know there were many edges to be found. As for the second guy, well it was common knowledge among the office and I have no reason to doubt series 7/63 licensed traders, what would one of the top guys in the company have to gain lying to me about that? Sure edges come and go, but the point is there are some amazing unknown traders out there, they just choose to remain anonymous.

I’ll give an example…back in 08 I was trading fanny vs Freddy, layering in small layers at 1000/1000, fading the spread based off certain stats mixed in with some art form. Anyways, the damn thing was really whipping around and I was green in the spread nearly everyday for months. Looking back on it now, I’m regret not really maximizing that edge (at the time my bread and butter was trading commodity stocks) and I didn’t fully appreciate the opportunity. I am sure as shit confident there were traders/hedge funds making an absolute killing on it, 5/6 figures everyday. Ps these were sent from my phone so I apologize for grammar/spelling.

People who doubt that there are traders out there who consistently make 8 figures year after year have never been in the business. I know 3 prop traders who have made at least 7 figures for 8 years in a row now. Not sure what their daily or monthly numbers are, but their yearly numbers are positive by a long shot every year.

former trader Wrote: ------------------------------------------------------- > People who doubt that there are traders out there > who consistently make 8 figures year after year > have never been in the business. > > I know 3 prop traders who have made at least 7 > figures for 8 years in a row now. Not sure what > their daily or monthly numbers are, but their > yearly numbers are positive by a long shot every > year. Yup. All these guys that believe this market efficiency bs are forgetting one crucial component, trading is talent; it’s no different than writing a novel, singing a song, throwing a football, etc. Yes there’s ways to harness and develop talent, but in it’s purity it’s something you either have or you don’t.

Im not doubting that their are traders that either A) make a killing nearly every year or B) never have a down day. It’s the overlap between the two that I doubt. Which is why I asked about the strategies / role in the firm. Anyhow, I’ll revist this post later when I’m not on my iPhone.