Information AGAINST an efficient market ?

Question

I think the "Efficient Market" hypothesis is bunk, yet there is so much written about it that it has become the predominant view. Do you know of any sites with academic papers / reports / articles etc. disproving this hypothesis? Perhaps in behaviorism studies?

(The best I have found so far is an academic paper studying the "World Cup effect" - countries that lose the world cup experience declines in their stock markets.)

Answer 1

The efficient market hypothesis (EMH) asserts that financial markets are "efficient", or that prices on traded assets, e.g. stocks, bonds, or property, already reflect all known information and therefore are unbiased in the sense that they reflect the collective beliefs of all investors about future prospects. The efficient market hypothesis implies that it is not possible to consistently outperform the market — appropriately adjusted for risk — by using any information that the market already knows, except through luck or obtaining and trading on inside information. Information or news in the EMH is defined as anything that may affect stock prices that is unknowable in the present and thus appears randomly in the future. This random information will be the cause of future stock price changes.

It is a common misconception that EMH requires that investors behave rationally. This is not in fact the case. EMH allows that when faced with new information, some investors may overreact and some may underreact. All that is required by the EMH is that investors' reactions be random enough that the net effect on market prices cannot be reliably exploited to make an abnormal profit. Under EMH, the market may, in fact, behave irrationally for a long period of time. Crashes, bubbles and depressions are all consistent with efficient market hypothesis, so long as this irrational behavior is not predictable or exploitable.

Answer 2

The strong form of the efficient market hypothesis states that it is impossible to consistently outperform the market--even if one is privey to insider information (so why was poor Martha tossed in the pokey?). The standard form simply says that it is impossible to consistently outperform the market without some sort of advantage such as insider information.

Therefor, Warren Buffet does not exist. Neither does Peter Lynch, or John Templeton.

Since those men do exist, the efficient market hypothesis is false. Apparently it IS possible to consistently outperform the market--for some, but not all. Obviously the market average performance IS the market.

The usual way of "proving" the efficient market hypothesis is through what is called a "straw man" argument. The researchers "prove" that outperformance is impossible, by assuming that the only possible stock picking formula is the one that is known to themselves, for example, the Cap M valuation model. Since these are PUBLIC KNOWLEDGE, make use of public information only, and are WIDELY USED, of course it is impossible to use them to outperform the market (yes, it is impossible for AVERAGE stock market participants to outperform the AVERAGE, by definition!).

In order to outperform the market, one would need to pick stocks by a proprietary formula, which is superior to those which are in the public domain and widely used.

Part of the purpose of duping people with the Efficient Market Hypothesis is to prevent average investors from questioning the garbage the investment banks are floating. If "every stock is fairly valued according to all public information", and if the orthodoxy states that "all relevent information is public", then Joe Average Investor has no reason to question the Enrons and Fannie Maes of the world.

When you buy an entire index trying NOT to pick stocks, then you are buying a lot of pure garbage; fraudulent shell operations with no profits that never will have any, whose whole raison d'etre is to sell stock.

If you want superior returns, simply filter out all possible shell operations. This is why some mutual fund managers won't buy any stock that does not return a dividend. A dividend is proof of profits--at least for a while--because corporations would not pay one indefinitely without some real profit.

One of my filters is to not buy the stock of any corporation that does not seem to have any real products. Companies whose lines of business sound like Dilbert's boss'es business-babble get tossed off my list of prospects.

There is more to it than that, but just by filtering garbage other people are buying, you will at least outperform those people.

Answer 3

I have a hard time agreeing with you. With the level of disclosure from public companies and the increased number of hedge funds in the industry it has become increasingly more difficult the find arbitrage in the markets.

Efficient market is not a behavioral thing. Its just the theory that all public information in the world in priced into the current price of a given security. I have to agree. Pick the most random, obscure stock you can think of and click on yahoo finance's message board. There are countless buyers and sellers of the stock that are constantly watching its every move.

Answer 4

Like many hypotheses, efficient markets is neither completely provable or disprovable. There is an assumption about information flows and liquidity that I don't believe can be observed in any current economies. It is interesting though, as information access improves, certain aspects of financial markets become more "efficient" acting ... however the amount and nature of information that is generally available is still not great enough to demonstrate a truly efficient market.

Although it is somewhat dated, the work of J.A. Schumpeter might be of interest. If memory serves correctly, he put forward some interesting work around monopolistic and oligopolistic competition models that are probably closer to what we currently see in many facets of the US economy.

Answer 5

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