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The paradoxical efficient market hypothesis (2024)

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Re: The paradoxical efficient market hypothesis (2024)

#31

Post by teiferer »

tennysont wrote: post #24
AnthonyMouse wrote: post #11

Earlier quoted context omitted.

> As people are forced to de-lever, everything goes down at once, often by very similar amounts, even though it cannot be possible that everything suddenly lost the same amount of value simultaneously. The price of something and the value of something were never expected to be the same. What's the value of food? If you have none you die, so the value is quite high, but the price is much lower than that because there…

Put another way: price is determined by need and supply (aka, demand curve meets supply curve). I would pay anything for air if I needed it, but I will gladly sell air in my yard for $1/m^3 because that air is worthless to me. Is air priceless or worthless? That is why price != value as most people think of it.

Not disagreeing with you, but isn't that already obvious from the fact that economic activity happens in the first place?

If you buy 5 apples from me for $5 then two things must be true: 1. The value that those 5 apples have to you exceeds the value that $5 have to you, at least at this very moment. Otherwise you would hang on to your $5 instead. 2. The value that those 5 apples have to me is less than $5 have to me, otherwise I would hang on to the apples.

The price of those 5 apples at this moment may be $5 but that doesn't reflect the value they have to neither me nor you. It's not the avereage either, necesarily. The only thing we know is that the value of them to you is higher and to me is lower.

Re: The paradoxical efficient market hypothesis (2024)

#32

Post by vintermann »

janalsncm wrote: post #23

Does the EMH state that prices will reflect on the price of a stock instantly? If not, I don’t think there’s a paradox. EMH would just mean it will eventually converge? I guess that makes it pretty toothless in practice then. I feel like the stock market is pretty divorced from fundamentals at this point i.e. speculation makes it more like a Keynesian beauty contest (picking stocks you think other people will think a…

Some institutional designs are more prone to Keynesian beauty contests than others.

It's instructive to compare "Crowdfunding" which took off with Kickstarter ~15 years ago, with "Equity Crowdfunding", which gets tried again and again, and has not a single success story to its name.

Kickstarter was made to fund artistic ventures, and for the first years, they were strict about only allowing that on their site. The idea was to reduce risk for e.g. people trying to bring their favorite band to the area for a concert.

On old Kickstarter, you only pledged to a project if YOU want the product/outcome for its own sake.

However, in "equity crowdfunding", where backers are tempted with a share in the profits of a venture, you should, if you are smart, try to ignore what YOU want. Your own wants are a source of error here: as a fan of the band, you're likely to overestimate its appeal. You should play the Keynesian beauty contest and try to guess what others want.

Kickstarter understood the difference very well. In the early years, they banned such things as "reseller's tiers". Some people would support e.g. a boardgame with pledging for five copies of the game, betting on its success and hoping to resell four of them. That brings the KBC factor in again, and Kickstarter thought that it would eventually lead to the site being flooded with the things everyone thought everyone else wanted, rather than the things they actually wanted.

There's a whole scam industry dedicated to exploiting the gap between what you want and what for its own sake and what you want because you think others want it: MLMs. MLM victims get tricked into a loop where they on one hand convince themselves that the product is great because they hope to sell it, and on the other convince themselves that the product will sell because it's great.

Re: The paradoxical efficient market hypothesis (2024)

#33

Post by Galanwe »

mg wrote: post #10

the hypothesis maintains that stock prices reflect all relevant information about the stock This is a common description of the EMH. But every time I read it, I think: Does information really directly impact the price of a stock? How? What if it takes 12 months of hard thinking to draw the right conclusion from the information? Are there many investors who go to such lengths? Are they all thinking at the same speed?…

> What if it takes 12 months of hard thinking to draw the right conclusion from the information?

I think the idea behind EMH is that this probability is priced in, at any point in time. It just so happens that longer term probabilities are discounted as more volatile, thus impacting less the present price.

Re: The paradoxical efficient market hypothesis (2024)

#34

Post by imtringued »

throw0101a wrote: post #6

See also: > The Grossman-Stiglitz Paradox is a paradox introduced by Sanford J. Grossman and Joseph Stiglitz in a joint publication in American Economic Review in 1980[1] that argues perfectly informationally efficient markets are an impossibility since, if prices perfectly reflected available information, there is no profit to gathering information, in which case there would be little reason to trade and markets wou…

This plays directly into fisher Black's "Noise" http://www.e-m-h.org/Blac86.pdf

Re: The paradoxical efficient market hypothesis (2024)

#35

Post by nearbuy »

mg wrote: post #10

the hypothesis maintains that stock prices reflect all relevant information about the stock This is a common description of the EMH. But every time I read it, I think: Does information really directly impact the price of a stock? How? What if it takes 12 months of hard thinking to draw the right conclusion from the information? Are there many investors who go to such lengths? Are they all thinking at the same speed?…

Information that requires 12 months to figure out isn't information that's available now.

Say you want to know the 400 trillionth digit of pi. We have all the information needed right now to know how to compute it. But you don't know what the actual digit is yet. The information isn't available and won't be until you set your supercomputer on it for some number of months. Having the information necessary to derive other information isn't the same as having the derived information.

If there is some information about a future stock price that could theoretically be computed after months of work, that's still not information that currently exists, and therefore is not currently reflected in the price. If no investors go to the lengths to get that information, it'll continue to not affect the stock price. It's not violating EMH because it's not information that exists yet.

Re: The paradoxical efficient market hypothesis (2024)

#36

Post by kqr »

derf_ wrote: post #7

Anyone who has lived through a market correction (the tariff announcements in early April this year being a recent example, though there have been far worse) should be able to see that market prices do not always accurately reflect even the consensus view of value (which itself can be wrong). As people are forced to de-lever, everything goes down at once, often by very similar amounts, even though it cannot be possib…

It seems like Bookstaber argues not that it's liquidity demand over information change, but that it is both. The tariff announcements are actually a great example, because it was triggered by new information, and diversification still kind of worked (at least some government bonds gained value during the drop in other assets classes).

The main question, I suppose, is why correlations were so high after the tariff announcements:

- In some cases, the high correlations are probably due to the markets being directly affected by the announcements: both commodities and equity are affected, and they got more correlated, which makes sense.

- In some cases, the high correlations are probably due to liquidity demand rather than markets being directly affected by the announcements: we would not expect cryptocurrencies to be directly affected by US tariffs, but they ended up correlated with equity markets anyway. That's probably because people needed to sell off their cryptocurrency to cover equity losses.

Thus in this case, it's again probably a bit of both.

Great paper. Thanks for referencing.

Re: The paradoxical efficient market hypothesis (2024)

#37

Post by dragonwriter »

nopassrecover wrote: post #20
AnthonyMouse wrote: post #11

Earlier quoted context omitted.

> As people are forced to de-lever, everything goes down at once, often by very similar amounts, even though it cannot be possible that everything suddenly lost the same amount of value simultaneously. The price of something and the value of something were never expected to be the same. What's the value of food? If you have none you die, so the value is quite high, but the price is much lower than that because there…

> The price of something and the value of something were never expected to be the same While I agree with you (quite firmly: it’s a great starting point to put on the table to challenge orthodoxy in this space), and think you’re agreeing with the parent comment, it is a fundamental tenet of mainstream economics and the political arguments of neoliberal (aka current mainstream) policy that [price == (market averaged)…

> While I agree with you (quite firmly: it’s a great starting point to put on the table to challenge orthodoxy in this space), and think you’re agreeing with the parent comment, it is a fundamental tenet of mainstream economics and the political arguments of neoliberal (aka current mainstream) policy that [price == (market averaged) value], or at the very least [price ~= value].

For mainstream economics, this is true in a very specific technical sense; all averages lose information, and the "market average" is a very particular form of average that doesn't behave the way most people think of an average behaving—particularly, it is not like a mean, the normal "average" that people think of, that is sensitive to changes in any individual values, it is somewhat like a median in that it is insensitive to changes in existing values that do not cross the "average"; e.g., if you take an existing market for a commodity with a given clearing price, and reduce, by any amount, the value of the commodity to any proper subset of sellers who would sell at the current market clearing price, the market clearing price does not change. The assessment of value across the market has decreased, but the output of the particular averaging function performed by the market has not.

Re: The paradoxical efficient market hypothesis (2024)

#38

Post by mg »

nearbuy wrote: post #35
mg wrote: post #10

the hypothesis maintains that stock prices reflect all relevant information about the stock This is a common description of the EMH. But every time I read it, I think: Does information really directly impact the price of a stock? How? What if it takes 12 months of hard thinking to draw the right conclusion from the information? Are there many investors who go to such lengths? Are they all thinking at the same speed?…

Information that requires 12 months to figure out isn't information that's available now. Say you want to know the 400 trillionth digit of pi. We have all the information needed right now to know how to compute it. But you don't know what the actual digit is yet. The information isn't available and won't be until you set your supercomputer on it for some number of months. Having the information necessary to derive ot…

That definition would mean that smarter investors, who can think faster and further ahead, get information faster. And therefore have information now that others do not.

That seems to be directly the opposite of the common definition of the EMH, which emphasizes how the market reacts to new information. And not how it produces information. For example in TFA:

"the market rapidly responds to new information"

Wikipedia starts the "Theoretical background" with an example on how information becomes widely available to all investors, not how one fast smart thinker generates it:

    Suppose that a piece of information about the value
    of a stock (say, about a future merger) is widely
    available to investors.
https://en.wikipedia.org/wiki/Efficient-market_hypothesis

Re: The paradoxical efficient market hypothesis (2024)

#39

Post by JetSetWilly »

GMoromisato wrote: post #3

This seems to be a case of a feedback loop creating emergent behavior. Let's say almost everyone believed in the Efficient Market Hypothesis (EMH). Then, trading would decrease significantly, since most people would think that stocks are already fairly priced. That means the few people who trade would move the market significantly, based on whatever idiosyncratic value-theories they had. But then the EMH believers wo…

Sounds a bit like the Adaptive Markets Hypothesis. In it there’s constant “evolution” between different trading strategies that become more or less efficient over time.

So here, Phase 1 would be a market dominated by EMH believers who passively invest. In phase 2, speculative “noisy” traders start to exploit this landscape to profit. In phase 3 there’s a crisis or period of high volatility. The old complacent EMH strategies suffer losses and become extinct. Then no doubt in phase 4 the market moves to some new equilibrium with new strategies dominant!

So in this AMH theory what you describe is a natural process of evolution.

Re: The paradoxical efficient market hypothesis (2024)

#40

Post by Terr_ »

GMoromisato wrote: post #3

This seems to be a case of a feedback loop creating emergent behavior. Let's say almost everyone believed in the Efficient Market Hypothesis (EMH). Then, trading would decrease significantly, since most people would think that stocks are already fairly priced. That means the few people who trade would move the market significantly, based on whatever idiosyncratic value-theories they had. But then the EMH believers wo…

> since most people would think that stocks are already fairly priced

Like the classic economist joke where they ignore a $100 bill on the ground: "It can't be real. If it were, somebody else would have already picked it up."

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