Thursday, January 14, 2010

Fama’s Fallacy

Listen to this excerpt from his interview with John Cassidy:

Back to the efficient markets hypothesis. You said earlier that it comes out of this episode pretty well. Others say the market may be good at pricing in a relative sense—one stock versus another—but it is very bad at setting absolute prices, the level of the market as a whole. What do you say to that?

People say that. I don’t know what the basis of it is. If they know, they should be rich men. What better way to make money than to know exactly about the absolute level of prices.

He makes this point several other times within a few minutes: we know markets are efficient because they are unpredictable.

But those famous monkeys, who sat at their keyboards for centuries hoping to randomly tap out Hamlet, could just as well be inputting unpredictable asset prices.

How can someone be a world famous financial economist and not know the difference between necessary and sufficient conditions?

2 comments: said...

There has long been evidence that there are periods where people using certain technical trading methods make more money than the market average. It is true, however, that those methods do not work forever, as others figure them out, which is a weakened version of ratex, if not EMH.

Curiously, Fama and French themselves effectively admit that strong form EMH does not hold, as their current view of when CAPM works is the "multi-factor" model, which brings in things that are not theoretically supposed be there, but do make the data fit better, gosh-a-whoop...

Anonymous said...

Surprisingly, world famous economists always seem to prefer tenured jobs to the exhilaration of the free market !