What efficient markets says is that prices today contain the available information about the future. Why? Because there’s competition. If you think it’s going to go up tomorrow, you can put your money where your mouth is, and your doing it sends (the price) up today. Efficient markets are not clairvoyant markets. People say, “nobody foresaw saw the market crash.” Well, that’s exactly what an efficient market is—it’s one in which nobody can tell you where it’s going to go. Efficient markets doesn’t say markets will never crash. It certainly doesn’t say markets are clairvoyant. It just says that, at that moment, there are just as many people saying its undervalued as overvalued.
To be filed under “not understanding the difference between necessary and sufficient conditions”.
3 comments:
It is also a tautology. While Fama is bad, Cochrane is substantially worse. The guy claims that all the students of Fama know about "fat tails" in financial market returns, except that "fat tails" (or even "kurtosis" or "leptokutosis") do not appear in the index of his widely used grad text, Asset Pricing. What a farce!
Do these guys ever even acknowledge the statistical evidence from people like Shiller that the prices of financial assets don't follow a random walk, or the argument there is no reason to expect them to since there's no easy arbitrage between asset price levels in different years?
"Efficient markets" = "Chaotic markets"?
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