
Kindly Stop Saying the Efficient Market Hypothesis Is Dead - jacobedawson
https://thedeepdish.org/efficient-market-hypothesis-is-not-dead/
======
matthewdgreen
This seems like a silly point. Are markets more efficient in the infinitely
long run than an individual who tries to identify the "correct" price? Quite
probably. Does the current stock market price at any given moment possibly
reflect the herd mentality of a bunch of jumped-up plains apes (or the
injection of a huge amount of funds by a central bank), rather than
representing the future expected earnings of a given asset? Also extremely
likely.

The performance of the markets during the lead-up to the pandemic was absurd.
It wasn't just the top-line market prices that were wrong: the obvious hedges,
like Put options, were all massively mispriced, to the point that even banks
started warning about it. This eventually corrected, but the correction itself
was extremely painful. Now the Fed is injecting dollars in order to help
"correct" the correction, with unknown long-term effects. (I don't know what
the EMH has to say about prices under this regime.)

Anyway, "the EMH is wrong" is an absurd simplification of the problem. The
real objection here is that asset prices may be right on average, in the long-
enough term, but are prone to huge over-confidence bubbles and corrections
that can wreak havoc on the actual human beings, and possibly lead to
suboptimal economic outcomes when prices are used to direct investment.

~~~
rmrfstar
EMH is a mental-model of equilibrium, and is useful when used that way.

Financial systems have multiple equilibria [1], so EMH "violations" come in
two flavors:

1\. Small deviation from equilibrium. This is where Renaissance Technologies
hangs out.

2\. Market herd expects the wrong equilibrium. This is where Nassim Taleb
hangs out.

On the scale of single years, 2 happens so rarely than you can't get
statistically significant measurements. So, we end up with endless
philosophical debates about whether EMH is "true".

[1]
[https://en.wikipedia.org/wiki/Diamond%E2%80%93Dybvig_model](https://en.wikipedia.org/wiki/Diamond%E2%80%93Dybvig_model)

------
erokar
Markets are not rational, they exhibit crowd psychology and as such are more
primitive and irrational than individual behavior. Quite a few professional
traders, hedge funds and even retail traders consistently outperform the
indexes. They are able to do this because they have recognized the fallacy of
EMH and are able to exploit the market's irrationality.

~~~
throw0101a
> _Quite a few professional traders, hedge funds and even retail traders
> consistently outperform the indexes._

In any one year there are a number of them do, but SPIVA has shown that over
the course of 5, 10, and 15 years that number gets smaller and smaller:

* [https://us.spindices.com/spiva/#/](https://us.spindices.com/spiva/#/)

Also: just because the market is not 100% efficient, and some folks can find
'weaknesses', does not mean it is not mostly efficient.

* [https://yourlogicalfallacyis.com/black-or-white](https://yourlogicalfallacyis.com/black-or-white)

Not even Fama, whose is often credited for formulating the EMH, has said that
it is 100:

* [https://en.wikipedia.org/wiki/Eugene_Fama](https://en.wikipedia.org/wiki/Eugene_Fama)

~~~
ternaryoperator
I don't disagree with the point you're making, but I should point out that one
reason some funds don't beat the S&P500 is because of the fees they charge,
which are deducted from their performance. In reality, their actual gross
performance is better than the S&P. However, the fact that the results are so
close to the S&P's performance that the fees alone can push them below it
supports your overarching point.

~~~
throw0101a
Further, in low-performance years, there is more of a headwind that must be
overcome to even earn a return (from the investor's POV).

------
wizzwizz4
A slightly different, more complete version by the same author can be found on
LessWrong. It has some clarifying edits (written in small writing), and
there's more discussion in the comments.
[https://www.lesswrong.com/posts/utySCY9nJt9xGYGGQ/the-emh-
at...](https://www.lesswrong.com/posts/utySCY9nJt9xGYGGQ/the-emh-aten-t-dead)

------
lisper
For any big market movement you will _always_ be able to find the person who
acted on it first. That person will always look like a prescient genius if you
just look at that one data point. To show a counterexample to the EMH you
would need to exhibit someone who can _consistently_ beat the market at odds
better than chance under proper controlled conditions. No single data point
can ever do it.

~~~
throw0101a
> _To show a counterexample to the EMH you would need to exhibit someone who
> can consistently beat the market at odds better than chance under proper
> controlled conditions._

See perhaps Renaissance's Medallion Fund:

> _The Medallion fund is considered to be one of the most successful hedge
> funds ever. It has averaged a 71.8% annual return, before fees, from 1994
> through mid-2014.[32]_

* [https://en.wikipedia.org/wiki/Renaissance_Technologies#Medal...](https://en.wikipedia.org/wiki/Renaissance_Technologies#Medallion_Fund)

People speculate that while mathematically half of trades must win and the
other must lose (for each side of a buy-sell), that Medallion may perhaps
'win' something like 52% of trades, but their volume is so high that the
(e.g.) 2% gives them their profit just like The House only needs a slight edge
when it comes to casinos.

~~~
lisper
Figuring out whether a given performance level is statistically significant is
incredibly difficult. You have to take into account a myriad factors: how many
other funds were there? The more total funds there are, the more likely you
are to find outliers. What was the risk-adjusted return, and what were the
underlying market conditions? It's trivial to take a consistently rising
market and amplify its returns: just apply leverage.

The fact that Medallion had this extraordinary return in a period that
included the 2008 crash is remarkable, but even then you would only have had
to predict a single black swan in order to avoid being impacted by it. And
even _I_ saw that one coming back in the day, and I don't really pay that much
attention.

------
trader1
The article reads like it was written by someone who has a deep interest in
finance, but hasn't worked much in the industry. Markets are quite efficient,
but there are pockets of risk premia driven by regulatory/intermediary
constraints and plain old behavioral bias. Then again, if he knew about them,
he presumably wouldn't write about them in an internet blog post.

------
fdsakjfsdfj
It might interest some people here to know that if the EMH were true, you
could use it to break unbreakable cryptography.

However that's not what would happen. If you tried it, your crack would fail,
and you would just end up proving experimentally that EMH isn't true.

That would move the discussion to "is it true except if you test it in weird
experiments though?" which is not an interesting point of debate:

Obviously there are no market participants with infinite wisdom and processing
ability who know all public news and factor it into every stock's price
instantly at all times, and are perfect in their analysis.

And have been since the dawn of markets, even before the Internet.

it's totally obvious.

Anyway here is a protocol you can use to demonstrate EMH is false, any time
you want:

[https://arxiv.org/abs/1011.0423](https://arxiv.org/abs/1011.0423)

~~~
rahimnathwani
This is a fun paper, and the logic seems sound. But the contrived situation is
nothing like real life, so it doesn't seem useful as a model.

------
greatwave1
Here's a dashboard I made that tracks the performance of the average Robinhood
user vs. the S&P 500 (using user holding data):
[https://www.quiverquant.com/sources/robinhood](https://www.quiverquant.com/sources/robinhood)

There's an argument to be made that the ability to consistently UNDERPERFORM
the market is evidence against the Efficient Market Hypothesis.

~~~
trader1
Trading costs are a thing. In an efficient market I would expect ex-ante
negative performance versus the benchmark.

~~~
greatwave1
True, although the method I used to find the aggregate performance of
Robinhood users ignored trading costs.

Obviously this data is incredibly noisy and nowhere near statistically
significant, but I like how it implies that betting against Robinhood traders
would've been an alpha-generating strategy over the last two years.

~~~
trader1
I agree that the data is quite noisy, and the choice of weighting (by users
instead of dollar value traded) may significantly influence results. Then
again, after reading r/wallstreetbets, I am not so sure ;).

~~~
greatwave1
Yeah, unfortunately Robinhood doesn't provide data on # shares held per user.

I've been doing something similar to track discussion on r/WSB here:
[https://www.quiverquant.com/wallstreetbets/](https://www.quiverquant.com/wallstreetbets/)

I haven't finished any backtesting yet to see if they live up to their
reputation haha.

------
vmception
Efficient Market Theory is dead because it is unfalsifiable.

It is not capable of being proved false, and should be discarded for that
reason.

Information asymmetries exist, not everyone with better information have the
access to capital or risk profile to alter the market price of an asset.

~~~
aaron695
Your first two sentences are very interesting.

> Information asymmetries exist, not everyone with better information have the
> access to capital or risk profile to alter the market price of an asset.

This is talked about in the article and seems to just start an argument again
and not explain the unfalsifiable statement.

~~~
vmception
Sorry if that weakens the argument to you. It is a separate thought. My point
is that "asset pricing" theories are too reductive, and should at least factor
in undercapitalized people that do not wish to speculate that can perceive
information. Or just abandon reductive asset pricing theories and focus on
other things. Promote liquidity and increases in transactions, "efficiency" in
that context, not "efficiency" in a "it already is and has been all the time
and forever" context.

~~~
aaron695
I think it's like the Shinichi Mochizuki mathematical proof.

If they can't play the game are they really part of it?

How do you know if you perceive true information?

I can tell you Magic Leap is a BS company and won't make any actual money. But
so can lots of people. So is that 'information', the answer is no. Real
information is when it will fail.

~~~
vmception
and that mathematical proof is much more sound than an economist's Efficient
Market Theory. QED.

------
xpe
This is a clarification question (probably for people that have studied or
read about the EMH in depth).

Wikipedia's definition is: "The efficient-market hypothesis (EMH) is a
hypothesis in financial economics that states that asset prices reflect all
available information."

The sentence above doesn't say how quickly the prices incorporate the
information. The rest of the Wikipedia article didn't really clarify my core
question (next).

Could someone give a summary of how the EMH is or is not framed in terms of
steady-state assumptions? In other words, does the core EMH theory concern
itself with dynamics? (Random walk theory does discuss dynamics.)

If there is a variation of theories that are all called "EMH", would you
please summarize some grouping you find useful?

------
anm89
Emh is almost tautologically ridiculous. Markets efficiently price the sums of
everyones actions based on their opinions regarding the underlying facts. It
doesn't price in some objective thing called "information". If one person
takes one bet based on a piece of information and another person makes the
opposite bet off of a differ wnt interpretation on the same piece of
information then neither of their strongly held opinions altered the market
price. If skewed numbers of people take those bets based on which side of the
bed they woke up on then the market skews to that side. There isnt some
conceptually perfect piece of "information" that is being priced here.

Not everyone has the same information, and not everyone interprets the
information the same way. All the market prices is the average of these
subjective opinions, and sure it does that efficiently, but that does not mean
that that price represents some perfect unbeatable truth.

My bank account would also like to disagree with EMH

------
hash872
How does the author explain the Renaissance Medallion Fund?

Also (and I asked this in the last big HN discussion of EMH too), how can EMH
co-exist with the existence of 'trading' as a profession? I don't mean day
traders, I mean professional traders who work for Goldman Sachs, investments
banks, etc. Every asset class in the world has dedicated, professional
traders.

If trading is fundamentally unprofitable over a long enough period of time....
why do sophisticated banks employ traders? (Wouldn't they, uh, have figured
this out already?) Assuming trading is profitable (for professionals with a
massive data advantage, etc.)- doesn't that disprove EMH? I can believe retail
trading is always unprofitable, but why do the pros do it?

~~~
tanvach
Hedge funds overall do not outperform index funds in the long run [1]. Banks
have moved mostly to sell side and their traders earn commission and bid-ask
spread. For a while the most profitable shops are market makers who use high-
speed trading to leverage tiny arbitage opportunities, profiting exactly from
tiny fluctuations from an efficient market.

[1]
[http://ftalphaville.ft.com/2018/04/24/1524542401000/A-comple...](http://ftalphaville.ft.com/2018/04/24/1524542401000/A-complex-
analysis-reaches-same-conclusion-as-simple-one--hedge-funds-suck/z)

~~~
hash872
>Hedge funds overall do not outperform index funds in the long run

But the Medallion Fund does apparently, which is my point. How can they have
70+% returns year after year for decades in a world where EMH is true? Their
existence seems to disprove it, no?

------
raverbashing
I think there are two important aspects that make the EMH not a good
predictor:

\- The markets move the prices themselves, so the prices are not the
"canonical" ones (if there was ever such a thing) but it reflects the idea
that the market itself has.

Betting on a certain outcome in a game doesn't change the possible results,
"betting on the market" does. So it's less about the "reality" and more about
what the market thinks.

The second aspect can be summed up by the phrase "one person is smart, but
people are dumb" (with the added component of "the market can stay irrational
longer than you can stay solvent")

So, the market is probably not efficient but that doesn't mean you can beat it
with ease.

------
nickpinkston
More interesting than "Is EMH dead?" is our improving understanding of the
efficiency of incorporating new information into markets is getting better.

I'll refer you below to Andrew Lo's "Adaptive Market Hypothesis" which:

"is an attempt to reconcile economic theories based on the efficient market
hypothesis (which implies that markets are efficient) with behavioral
economics, by applying the principles of evolution to financial interactions:
competition, adaptation and natural selection."[1]

[1]
[https://en.wikipedia.org/wiki/Adaptive_market_hypothesis](https://en.wikipedia.org/wiki/Adaptive_market_hypothesis)

------
lend000
The analogy I always use (similar to the joke about the economist not picking
up a twenty dollar bill) is that the market is as efficient as an evolved
jungle ecosystem. Most of us would consider this system highly efficient,
certainly more so than one our government could design, but it doesn't mean an
animal shouldn't be able to find food. It just means it requires _energy_ to
find it -- or, in the economy, to determine a more accurate future price.
There's no free lunch.

------
littlestymaar
The efficient market hypothesis has a really questionable name which is a
recurrent source of confusion: it's not about markets being efficient (in
terms of resources allocation), it's about the inability to efficiently
forecast assets price. The former isn't necessary for the later to be true.

------
olliej
This is nonsense, ignoring the social/human aspects of it, the "efficient
market" hypothesis only works if competition is possible (e.g. no monopoly,
minimal capital startup costs), and if P=NP.

------
ivalm
One thing this blog doesn’t address is price elasticity/liquidity.

There is far less friction and chance to get front-run if you are dealing with
$100k rather than $100M.

------
mjfl
It is trivial to outperform the market by insider trading, thus markets are
inefficient. The efficient market hypothesis isn't dead, it was never true.

~~~
perl4ever
I think empirically it's neither trivial nor impossible.

For instance, say you are a CEO and earnings are about to be announced for
your company. You know exactly what the earnings are going to be, and what the
published expectations are, so you know how much they will beat or fall short.
Does that mean you know how the market will react? I think people who have
been in that position would tell you no.

There was something in the news about someone who hacked into a database with
earnings press releases that gave them access just a little early. And someone
did an analysis of how reliably this worked to make money. It wasn't 100%!

~~~
mjfl
If you frontrun a merger or a huge earnings miss, there's nearly a 0 percent
chance you will lose money, and you can further leverage with options.

------
gonzo
the efficient market hypotheis isn't dead, but markets are efficient only if P
== NP [https://arxiv.org/abs/1002.2284](https://arxiv.org/abs/1002.2284)

~~~
rahimnathwani
Someone posted a similar (but later) paper above:
[https://news.ycombinator.com/item?id=23371766](https://news.ycombinator.com/item?id=23371766)

------
mewpmewp2
Finally some sense. I am so tired of people complaining about markets being
irrational

------
jkhdigital
“The Market” is a leaky abstraction for the collective activity of millions of
individual humans making concrete decisions at specific points in time. The
EMH says something about the model, not about reality, so there will always be
a gap.

------
zenlot
EMH is dead.

------
arminiusreturns
Money printer goes brrrrrr.

Effecient markets!

------
meesterdude
First off, I don't like titles telling me what to do. You're not my real mom.

Second, this was more incoherent babble than useful. While I am an investing
nerd, this article could be about 1/3rd as long. The rest was trash writing
and ego.

Third, there _is_ some worthwhile content in that 1/3rd that's good. But it's
nothing groundbreaking or new, and detached from the EMH topic. His
perspective on Warren Buffet was worthwhile, though, and the idea that once a
tactic goes public the collective abosrbes it and the edge is lost is worth
pondering over, and the comparison of using a stone-age axe against a fighter
jet is meaningful too. There's no real discussion around the lifetime of
tools, techniques, and perspectives. That might be the most worthwhile
takeaway for me.

Forthly, equating market action to coin tossing is intellectual laziness. I
would agree with this on an intraday trading level, but in long term investing
that's just not the behavior equities exhibit.

Lastly, my portfolio has beat the S&P500 by significant margin (>3-8x) for 5
years. I'm still waiting to get humbled so i can investing in the S&P500/bonds
and call it a day. If history is any indicator, it should be an eventuality.
But given the perspective that stone-age axes don't work against fighter jets,
I wonder how that could come to pass.

