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Markets are Efficient if and Only if P = NP

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Re: Markets are Efficient if and Only if P = NP

#41

Post by jerf »

aphyr wrote: post #35
jerf wrote: post #29

Earlier quoted context omitted.

As much fun as the other reply is, the real defense against your point is that "efficient" doesn't mean what you think it does. Efficiency in a market means that there exist no long-term arbitrage opportunities, because they will be exploited and thus cause prices to shift until those no longer exist. It emphatically DOES NOT mean "good" or "desirable" or anything like that. The market very efficiently went over a cl…

Jerf, this is a surprisingly insightful and concise statement--one that I largely agree with. I'm curious, though, and want to ask CWuestefeld as well: If we accept that the free market can act in ways which are detrimental to the global objective function (without loss of generality, let's pick your favorite, e.g., "Everyone gets food", "Individuals have class mobility", "I can shoot and eat the homeless for sport"…

It's why I'm a little-L libertarian; free markets can and will efficiently price and trade in evil. Slaves were once traded on the open market, after all, and they were probably efficiently priced, but that certainly doesn't make it a good thing. (Just to hit the point again, efficiency has very little to do with "good".)

I think it's possible to regulate effectively, but the problem is that it requires an engineer's approach, not a government's approach. One must be able to adapt, admit one is wrong, and generally regulate at the incentives, instead of being required to stay politically viable and only then regulate, be politically unable to admit error (and via the mechanisms of politics, become insulated from the facts that would show error), and be continuously stuck in the regulation of the effects instead of the incentives that got us there. Oh, and as I alluded to previously, being regulated by people who won't even look at the mechanics of the market squarely because they think they're intrinsically evil because sometimes they make bad things happen (which they definitely do!) isn't a great start to engineering success.

Yes. The market can be evil by human standards, just as gravity feels pretty evil when you're in a crashing plane. But you gotta deal with what really exists, not what you wish existed, and when harnessed properly it's one of the bigger forces for good we've ever discovered.

Re: Markets are Efficient if and Only if P = NP

#43

Post by fleitz »

jbooth wrote: post #8
CWuestefeld wrote: post #6

Earlier quoted context omitted.

While I'm pretty much a free-market zealot, I'm also a Hayek groupie. It seems to me that Hayek's work should show us that markets approach perfect efficiency. Because the market is a hideously complex system that only produces its information as an evolved, emergent system, then it is likely that its output is not precise but only extremely close to optimal.

Was the fall of 2008 "extremely close" to optimal? I'd submit that worldviews based on 1-dimensional criteria like "market!" or "hayek!" fall pretty far short of the mark. Although I can see the attraction. It's nice to simplify things to a level where a human being can actually have the answers with a high degree of confidence. Both the tea-party-hayekians and the linked paper fall into this trap.. what about inform…

Yes, the fall of 2008 was extremely optimal, did the US gov't see the problem beforehand and fix it? No they didn't, it was the market that brought the information to everyone that something was seriously amok in the financial system. (eg. Bear Stearns is bankrupt). It was short sellers, and all the people we love to hate that brought the problem to attention and moved prices to reflect the true value of these companies. (eg. zero)

Efficient market hypothesis does not predict that the market will have perfect information or perfect pricing, or that stock prices will go infinitely up. It predicts that over the long term the market provides reasonably accurate pricing.

Re: Markets are Efficient if and Only if P = NP

#44

Post by CWuestefeld »

aphyr wrote: post #35
jerf wrote: post #29

Earlier quoted context omitted.

As much fun as the other reply is, the real defense against your point is that "efficient" doesn't mean what you think it does. Efficiency in a market means that there exist no long-term arbitrage opportunities, because they will be exploited and thus cause prices to shift until those no longer exist. It emphatically DOES NOT mean "good" or "desirable" or anything like that. The market very efficiently went over a cl…

Jerf, this is a surprisingly insightful and concise statement--one that I largely agree with. I'm curious, though, and want to ask CWuestefeld as well: If we accept that the free market can act in ways which are detrimental to the global objective function (without loss of generality, let's pick your favorite, e.g., "Everyone gets food", "Individuals have class mobility", "I can shoot and eat the homeless for sport"…

That's a fair question, but don't let it suck you into a "false choice" fallacy.

There are plenty of real-world examples of this. In all cases, free trade will make all parties better off on the whole. However, the effect of doing so may be that individuals at the margin lose out, e.g., an unskilled factory worker may find that someone in China is doing what used to be his job. It's pretty well decided now (although not without any controversy) that, at the margin, minimum wage laws increase unemployment in the lowest-paid workers.

The fact that some deregulation may have (localized) negative consequences shouldn't automatically disqualify them: there are more choices than just "let the market run free" vs "continue the regulation". We can, for example, get the benefits of that free trade, and use a portion of the economic gains to finance job retraining programs.

However, I'd also like to point out an implicit assumption in your question that may be problematic. You refer to "the global objective function". Part of our difficulty is that there isn't such a global function that all can agree on. Indeed, it may be that some of our utility functions are mutually exclusive. Many people would say that we should optimize for full employment, but I personally think that's bunk: there are plenty of people who don't want to work, but do so because they need to buy food; they'd rather take care of the kids while the spouse works. The adoption of a single utility function to govern the country (something, it seems to me, that both Conservatives and Liberals would like to see) sells out American individualism, and the diverse lifestyles and values of our people.

Re: Markets are Efficient if and Only if P = NP

#45

Post by CWuestefeld »

nirvana wrote: post #30
jbooth wrote: post #8

Earlier quoted context omitted.

Was the fall of 2008 "extremely close" to optimal? I'd submit that worldviews based on 1-dimensional criteria like "market!" or "hayek!" fall pretty far short of the mark. Although I can see the attraction. It's nice to simplify things to a level where a human being can actually have the answers with a high degree of confidence. Both the tea-party-hayekians and the linked paper fall into this trap.. what about inform…

I would say the fall of 2008 was pretty close to optimal, especially in terms of what Heyek would predict. That is not to say it was good for the population, but it was a reasonably efficient reaction to the information the market had about the state of affairs. Note that it didn't fully reflect the entire state of affairs because the market did not have sufficient information, and still doesn't. (I think if it did,…

I voted you back up because I don't think you deserve to be negative.

But I'd challenge your claim that you can actually profit from the general economic ignorance. The reason I'm so skeptical is because the market is so good at working around inefficiencies that even when we think something's got to collapse, it finds a way to keep going. (if you'll excuse me for anthropomorphizing)

Re: Markets are Efficient if and Only if P = NP

#46

Post by fleitz »

bermanoid wrote: post #23
CWuestefeld wrote: post #15

Earlier quoted context omitted.

I'm not sure you understand what the free market is, or how it works. The fall of 2008 wasn't a free market. In particular, the government was forcing lenders to accept more risk (viz sub-prime borrowers) than they would otherwise have done. Also, the lenders themselves incorrectly modeled their risk exposures. None of your objections: what about information asymmetry? What about borked incentives? What about just pl…

Bad incentives: it's the incentives (see "Invisible Hand") that make things work properly! To the extent that the incentives are wrong, these are the regulations, the aberrations that make things deviate from the free market. It's fairly common for traders managing (or depending how you look at it, gambling) other people's money to be paid a percentage of the total money under management (for the sake of argument, le…

The stock market merely reflected the balance sheets of large financial institutions. The stock market drop did not cause Bear Stearns to go bankrupt, Bear Stearns being bankrupt caused the market to collapse. That triggered enough insurance policies that AIG went (or would go), and GS had enough insurance with AIG that it would go if AIG went.

Re: Markets are Efficient if and Only if P = NP

#47

Post by arethuza »

doyoulikeworms wrote: post #36
jbooth wrote: post #25

Earlier quoted context omitted.

I'm criticizing fundamentalist market theory, and the practice of turning your brain off. The crash of 2008 was preceded by 20 years of deregulation. And the explanation? Too much regulation! A billion dollars in loans to minorities must explain the 2 trillion dollar problem! There's nothing wrong with thinking a free market's the way to go for a given problem, provided you got there by engaging your brain rather tha…

In what way is it "turning your brain off" to consider the 2008 crash the result of too much regulation? The mother of all financial regulatory machinery, the central bank, is considered to be the primary cause of the crash by many. I find the argument reasonable. Correct or not is another story, but how can you dismiss the statement wholesale?

"I find the argument reasonable."

Care to share a reference that backs up that argument? I'm not doubting that there may be an argument, just interested to read that point of view.

Re: Markets are Efficient if and Only if P = NP

#48

Post by gsmaverick »

jbooth wrote: post #38
doyoulikeworms wrote: post #36

Earlier quoted context omitted.

In what way is it "turning your brain off" to consider the 2008 crash the result of too much regulation? The mother of all financial regulatory machinery, the central bank, is considered to be the primary cause of the crash by many. I find the argument reasonable. Correct or not is another story, but how can you dismiss the statement wholesale?

The, uh, the united states doesn't have a central bank. I don't want to be nitpicky here, but this is a conversation about not turning your brain off. Are you referring to the federal reserve? They don't regulate anything. The SEC? They're in no way similar to a central bank and have been regulating progressively less over the last 70 years. What changed in 2008 that made their regulation more burdensome? If you're m…

The United States does have a central bank; it's the Federal Reserve. They kept interest rates abnormally low for much of the last decade which meant that borrowing was incredibly cheap causing many consumers to overextend themselves. Regulation, government intervention they're the same thing. It is undeniable the government intervened in the housing market and this was discussed earlier in this thread[1].

[1] http://news.ycombinator.com/item?id=2896728

Re: Markets are Efficient if and Only if P = NP

#49

Post by jbooth »

jerf wrote: post #39
jbooth wrote: post #31

Earlier quoted context omitted.

Well, I certainly can get behind your definition more.. but a gigantic 10 year bubble sticking out to the side and then bursting doesn't seem efficient by that definition. You'd think the wizards of the market, with the billions of dollars in pay they're collectively bringing home, would've corrected for that sooner, no? This concept that in 2008 the market was responding to incentive misalignments created by governm…

"but a gigantic 10 year bubble sticking out to the side and then bursting doesn't seem efficient by that definition." Where was the enormous arbitrage opportunity left behind, and why didn't you (or anybody else) exploit it? Maybe you can answer that, but if you can't, you're not arguing for "inefficiency", you're still arguing "not good". You also appear to be conceiving of regulations as something you simply have "…

The original contention was "extremely close" to optimal. I'm merely contending that the markets fuck it up big occasionally here, pretty low hanging fruit for me. As for why I didn't exploit it? I don't know, I don't work on Wall Street, don't play that game? I could've told you that the mortgage thing was a problem long before the ratings agencies, apparently, but everyone knew in hindsight.

Anyways, 10 years is pretty darn not good in my opinion. I'd call it inefficient, as far as pricing is concerned.

Agree on "more or less" regulations being a not-useful mental model. It seems to follow from that contention that "regulations!" isn't a one-word answer to any question of who to blame for anything, or how to solve anything.

RE: Fannie and Freddie I have not looked at their balance sheets. I'm under the impression that whatever the problem is with them, it's dwarfed by the size of the financial crisis, ergo they're not primarily at fault for the crisis. Moreover, the program to lend to minorities had been in place for decades. Seems hard to blame it for the 2008 meltdown, why not sooner?

It does seem that any regulations putting institutional faith in the ratings agencies are wrong-headed.

Re: Markets are Efficient if and Only if P = NP

#50

Post by CWuestefeld »

arethuza wrote: post #47
doyoulikeworms wrote: post #36

Earlier quoted context omitted.

In what way is it "turning your brain off" to consider the 2008 crash the result of too much regulation? The mother of all financial regulatory machinery, the central bank, is considered to be the primary cause of the crash by many. I find the argument reasonable. Correct or not is another story, but how can you dismiss the statement wholesale?

"I find the argument reasonable." Care to share a reference that backs up that argument? I'm not doubting that there may be an argument, just interested to read that point of view.

I think the parent post overstates it a bit. I wouldn't say that the Fed was a primary cause, although they were certainly complicit by keeping interest rates so low, artificially increasing the demand for mortgages.

If you're willing to generalize the comment to say that the crisis was primarily due to the heavy hand of the federal government, then I offer these two links. They're both op-ed pieces, so shouldn't be considered definitive research, but they're pretty solid evidence that some serious people do blame the government's regulation (as opposed to de-regulation).

1. A Government-Mandated Housing Bubble http://www.forbes.com/2009/02/13/housing-bubble-subprime-opi...

2. How Government Stoked the Mania http://online.wsj.com/article/SB122298982558700341.html

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