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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

#31

Post by jbooth »

jerf wrote: post #29
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…

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…

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 government regulation.. what regulation? All we did was deregulate from 92 onwards. Are you gonna claim that a billion in fannie/freddie loans to minorities caused the problem? What about the overleveraging, the AAA credit ratings? Those were government problems?

It seems like a whole bunch of individuals played the "greater fool" theory as long as they could, and what we wound up with was the opposite of efficient, by your definition. I'm not necessarily saying more regulation would've prevented that, aside from generally being a brake on everything, but it's a hell of a bad case for the wisdom of markets.

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

#32

Post by CWuestefeld »

jerf wrote: post #29
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…

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…

Thanks for that explanation. I don't think I've ever seen it put so concisely before, and I've never been able to say it that well at all.

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

#33

Post by ChuckMcM »

ColinWright wrote: post #2

It feels to me that all he's done is show that the "instantly" in the usual definition of markets being "efficient" is a nonsense. Prices must take time to compute, you can't know the correct price instantly even with access to all the past information. He proves that, but it doesn't seem that surprising to me.

Pretty much in a nutshell his exposition. For me, my interest lies in the economic value of information, and one way in which information gains value is by being 'timely.'

When explaining to folks I often use the example that the 15 minute delayed stock price feed (aka 'ticker') is less valuable than the real time stock 'ticker'. This is intuitive for many folks but the OP's work shows the math behind that intuition.

Stock price feeds are generally used by algorithms to anticipate the market price of a commodity and act when there is a delta between that and reality. They 'manufacture' new information by taking that real time stock feed and identifying trends. Their market value then becomes a function of their ability to identify trends sooner and thus allow for capturing the most value between the current price and the correct price.

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

#34

Post by tmeasday »

zeteo wrote: post #13

Even if the problem that markets are trying to solve is NP hard, this doesn't mean anything. Market forces are always subject to random factors. For practical purposes, randomized approximation algorithms are actually a great choice for tackling NP hard problems.

Sometimes. I think the simple answer to that is 'it depends on the problem'.

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

#35

Post by aphyr »

jerf wrote: post #29
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…

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" etc.), do we as a society have a moral obligation to adjust market behavior via regulation or incentives? How does one reconcile a desire for free markets with a desire to satisfy other human goals?

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

#36

Post by doyoulikeworms »

jbooth wrote: post #25
CWuestefeld wrote: post #22

Earlier quoted context omitted.

when you pigeonhole yourself into an absolutist position That's a fair criticism of my reply. My initial statement almost had a flavor of "free markets are perfect", whereas what I really believe is that "free markets are the best system possible". So, no true scotsman? But I don't think that's a fair criticism. There is a clear, well-defined concept of "free market"; it's not like I keep backing off my statement eve…

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?

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

#37

Post by ekiru »

CWuestefeld wrote: post #15
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'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…

> For example, in The Myth of the Rational Voter[1], Caplan describes how it's actually rational behavior for voters to vote irrationally: the benefit of the degree they can sway the election is far smaller than the cost of acquiring sufficient knowledge to determine what candidate would most benefit them.

This is a minor detail, given that that was just an example you were giving; but in case it piqued anyone's interest, I'll correct it. That's not actually the explanation Caplan gives for voters acting irrationally (indeed, there's nothing that even appears irrational about that; that's obviously rational behavior). What Caplan argues is that voters rationally vote irrationally because they have preferences over beliefs, giving voting in accordance with false but preferred beliefs psychological benefits, and that if these psychological benefits outweigh the negative effects of the irrational voting, discounted by the low probability of deciding the election, it is rational to vote irrationally.

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

#38

Post by jbooth »

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?

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 making a statement, it's on you to back it up. Shouting "regulation!" with no insight behind it might work in your social circle but in mine, it's turning your brain off.

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

#39

Post by jerf »

jbooth wrote: post #31
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…

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 "more" or "less" of, which is not a useful mental model. What matters about regulations is their content, not their quantity. And what the content of our regulations created was A: mandating that banks make loans they would not have made without them and B: an implicit government backing for those bad loans.

Have you looked at the balance sheets for Fannie & Freddie lately? They're not bleeding a billion here or there.

Also, yes, the credit rating agencies are government creations as well. There are regulations (ahem) that require certain entities to take certain actions based on the word of the rating agencies, causing them to no longer just be groups of people stating their opinion, skewing their own incentives and raising the incentives others have to game them.

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

#40

Post by CWuestefeld »

jbooth wrote: post #31
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…

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…

This concept that in 2008 the market was responding to incentive misalignments created by government regulation.. what regulation? All we did was deregulate from 92 onwards.

This is false. The Community Reinvestment Act, passed in '92 and periodically ratcheted upwards thereafter, forced banks to increase loans to minority groups. It issued guidelines on how lenders should evaluate borrowers for these purposes:

Affirmative-action policies trumped sound business practices. A manual issued by the Federal Reserve Bank of Boston advised mortgage lenders to disregard financial common sense. "Lack of credit history should not be seen as a negative factor," the Fed's guidelines instructed. Lenders were directed to accept welfare payments and unemployment benefits as "valid income sources" to qualify for a mortgage. [1]

While not a regulation issue as such, it's also true that attempts to rein in Freddie Mac and Sallie Mae (semi-governmental entities both) were rebuffed by Congress; even when we knew there was potential trouble, the regulators wouldn't allow market concerns to dictate to their beast.

[1] http://www.boston.com/bostonglobe/editorial_opinion/oped/art... (note this link took forever to come up in my browser)

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