And now that is a caveat

538 has probably the best caveat regarding the efficient market hypothesis in a discussion about the NFL draft:

The efficient-market hypothesis states that — with certain caveats — markets are informationally efficient. Since any one investor theoretically operates with the same set of information as any other,2 the EMH claims that no individual can consistently achieve risk-adjusted returns in excess of the market-wide average. This conclusion, most notably proposed by University of Chicago professor Eugene Fama in the 1960s, isn’t perfect (it can’t explain speculative bubbles, for instance), but it’s a testament to the power of an ideal market. [emphasis is mine]

Other than saying that the biggest two fianncial stories  (dotcom and housing bubbles) of the past fifteen years can’t happen, this is a solid predictive hypothesis

Not quite a “how was the play Mrs. Lincoln” but still a damn impressive caveat.

58 replies
  1. 1
    clawback says:

    Should have said, “with notably rare exceptions …”

  2. 2
    JGabriel says:

    Richard Mayhew @ Top:

    Other than saying that the biggest two fianncial stories (dotcom and housing bubbles) of the past fifteen years can’t happen, this is a solid predictive hypothesis.

    With notably rare exeptions, of course.

  3. 3
    Mike G says:

    It works great in theory (apart from the footnoted exceptions you could drive a truck through) which is what matters to academic economics. Most of the field has devolved into self-referential mathematical masturbation.

  4. 4
    Seanly says:

    Since any one investor theoretically operates with the same set of information as any other

    Umm, doesn’t reality kinda blow this statement out of the water? In what market would all investors have the same set of information? They would all have different experiences & knowledge.

    This seems like the type of theory that fits enough of the time to be used in the freshmen & sophomore classes as an introduction to more rigorous theories.

  5. 5
    chopper says:

    “that would be a great point, if it were true.”

  6. 6
    different-church-lady says:

    “In theory there is no difference between theory and practice. In practice there is.” — Yogi Berra

  7. 7
    Gin & Tonic says:

    If the EMH were true, Warren Buffett would not exist.

  8. 8
    KG says:

    @Seanly: not only everyone having access to perfect information, everyone being able to analyze the information as well.

  9. 9
    phantomist says:

    Goldman Sachs had 236 profitable days of trading last year (and just 15 days of losses)
    By Zachary M. Seward March 1, 2013

  10. 10
    srv says:

    I think that if anyone is going to argue with glibertarians, that the focus should be on debunking that they are, in any demonstrable way, rational actors and the playing field is level.

    If they were rational actors, they should have been shorting the dollar for the Amero and Peter Schiff should be worth a $100B or so.

    Why isn’t Rand Paul a billionare?

  11. 11
    different-church-lady says:

    @Gin & Tonic:

    If the EMH were true, Warren Buffett would not exist.

    We should take into account the deceptions of sample size. The larger the market, the more likely EMH is to be somewhat accurate. EMH has absolutely no bearing on how any given individual would do. Or, for that matter, how any individual decision goes. (Tom Brady in the 6th round?)

    ETA: In other words, EMH is a theoretical ideal, not an absolute. But (and probably the most important point), people treat it as though it were an absolute so that they can champion loose rules and bad behavior.

  12. 12
    Villago Delenda Est says:

    markets are informationally efficient

    Glad I finished my coffee earlier, as otherwise it would be all over my keyboard and monitor right now.

    This can be true only in hermetically sealed academic market simulations, which are apparenlty the only ones in which jackholes like University of Chicago economists every bothered to observe.

    Because in the real world, it’s simply not possible for all actors in a market to have the same information upon which to make decisions. In the case of the NFL draft, something as seemingly trivial as a medical report on a prospect’s ingrown toenail can have profound effect on the actors.

  13. 13
    Gin & Tonic says:

    @different-church-lady: That line is attributed to many people, just as “it is difficult to make predictions, especially about the future.” But anyone who ever heard Yogi speak would, IMO, never seriously attribute either to him, which the Internet does.

  14. 14
    roc says:

    “Assume a spherical cow” is a punchline. But “assume this set of conditions that are never true in practice” is a testament to the power of a model? I’d laugh if these people weren’t serious and too-often in control of policy.

    If you ask me it’s a giant flashing warning sign of just how far economics has to contort itself to validate preconceived political positions.

  15. 15
    Mnemosyne says:

    @Mike G:

    IMO, the problem is that economics is a social science that likes to pretend it’s a hard science (See, we have numbers! That makes us just like physics!) But economics is far more dependent on psychology and sociology than it is on math, no matter how hard the University of Chicago tries to pretend otherwise.

  16. 16
    different-church-lady says:

    @Gin & Tonic: “I never said most of the things I said.” — Yogi Berra.

  17. 17
    Someguy says:

    Most of the teams have more or less equal information. Judging the information is what is difficult. It isn’t the market’s fault that Seattle and San Fran are good judges of talent, that the Browns can’t tell shit from shinola. The Jets, on the other hand, are why we need to nationalize Draft Day. They need to be protected from themselves.

  18. 18
    Trollhattan says:

    I have Jamarcus Russell and Ryan Leaf on line 3 for a conference call…..

  19. 19
    different-church-lady says:

    @roc:

    I’d laugh if these people weren’t serious and too-often in control of policy.

    QFT. It’s what I find maddening about the ACA — sometimes policy makers with good intentions view individuals with the same lens that generals see individual troops.

  20. 20
    Villago Delenda Est says:

    @JGabriel: You know, this is one of those times that I wish I was in line for a movie, and Greenspan is blathering on about “the invisible hand” behind me, and then I reach offscreen and bring Adam Smith into the conversation and he informs Greenspan that he doesn’t have the slightest clue as to what Smith was writing about.

  21. 21
    Greg says:

    Given the NFL combine system, where all the players are seen and tested by all the teams simultaneously, the efficient market hypothesis is probably more true for the NFL draft than for any other real world market ever.

  22. 22
    different-church-lady says:

    @Greg: But the combine only tells teams how a player performs in a combine environment. (Which is tangential to your point, with the tangent heading towards the mysteries of testing rather than the wisdom of crowds.)

  23. 23
    Gin & Tonic says:

    @different-church-lady: Not true. From Wiki: “Semi-strong-form efficiency implies that neither fundamental analysis nor technical analysis techniques will be able to reliably produce excess returns”

    Buffett, using fundamental analysis, has reliably produced excess returns. The “sample size” is everybody else.

  24. 24
    Villago Delenda Est says:

    @Someguy: You see, that’s where the pesky human interaction gets into the process and breaks the hermetic seal around the model and fucks up all the predictions of the jackholes of the University of Chicago.

    It’s like UNIX system administrators bemoaning how the system would run perfectly with a near infinite uptime if it wasn’t for the damn lusers screwing things up by using the system.

  25. 25
    Al Swearengen says:

    The draft will be interesting because Michael Sam is apparently going to be judged only on running the 40 less than half-second slower than Clowney and not knocking SEC O lines down like bowling pins all year.

    His Combine performance has given the NFL establishment an out. A better excuse “We gotta go with the numbers” (while ignoring his college career) than “Oh noes! Gaytroversey in the locker room!1!”

  26. 26
    mdblanche says:

    Aside from that, if the reviews are anything to go by the rest of the play sucked too.

  27. 27
    catclub says:

    @clawback: To the dismay of many on the left.

  28. 28
    scav says:

    @Mnemosyne: They should be far more dependent on humans and psychology and empiricism and real-world data. Rather, it’s become an unacknowledged branch of video gaming theory, only with Wall Street and London et alia (eventually Main Street) as their “virtual” environment. Wheeeeee! Lookie Mom, No Hands!!!

  29. 29
    chopper says:

    with a few rare exceptions, Germany was a very peaceful country during the first half of the 20th century.

  30. 30
    catclub says:

    @roc: My understanding of the Born approximation is just the opposite of the economic models. It is explicitly recognized as being invalid in a large region where it is applied, but you still get GOOD predictions from it.

  31. 31
    jl says:

    @Mnemosyne: True.

    RM will go mad if he keeps worrying about this stuff..

    Like many theorems and propositions in microeconomics, hard to say whether these rational expectations hypotheses are empirical statements or intellectual frameworks used to cook up cool models on paper, and can be fiddled with to explain anything that could ever happen.

    Heck, the theory of rational bubbles has been around since the late 1980s. And if a guy with an eye on the main chance can make some money before it crashes why is it not rational to jump on it and cash in? I think the idea that bubbles cannot exist comes more from the ever and always present auxiliary assumptions in these fancy models, in this case, the fashion for writing down models that directly or indirectly assume infinitely lived agents (either individuals in the models who live forever, or ‘dynasts’ who care about the welfare of their children down through the ages). You put a strong version of efficient markets hypothesis together with infinitely long intertemporal utility maximization, those two together make the bubbles go away.

    I never figured out how efficient market hypothesis, in its stronger forms, can co-exist with the impossibility of informationally efficient asset markets, which says that if market prices reveal all existing private information perfectly, it can never pay for any individual to invest in gathering the information that will be perfectly revealed as soon as it is used to make a market transaction big enough to change prices (I think that idea was first formalized by Grossman and Stiglitz).

    Glad that there is BJ front poster willing to sacrifice sanity to worry about this stuff, so I don’t have to. Keep ’em coming.

  32. 32
    scav says:

    The power of the model, however, may be demonstrated by our not having strangled the last economist and banker in a dark alley with the entrails of Bill Clinton.

    Yet.

  33. 33
    Andrey says:

    The problems with EMH are not problems with the field of economics. In physics, you can make simplifying assumptions like “ignore air resistance” all the time and it’s perfectly reasonable. In computer science, one of the most common ways to study an algorithm specifically ignores all constant factors – meaning X and 10000 * X are treated the same. These work perfectly well when applied correctly within their field.

    The problem with EMH is that several major political movements decided to latch onto and co-opt economics as one of their rallying cries, and they use the concepts without understanding what they mean and what they’re actually useful for. And this has lasted long enough that there are many “economists” who are really politicians and propagandists that are good at draping numbers around their social arguments.

    Think of how creationists insist “The second law of thermodynamics proves evolution is false!” – it’s not that the second law of thermodynamics is bullshit, it’s that they don’t understand the thing they’re trying to latch on to.

  34. 34
    Greg says:

    @different-church-lady:

    @Greg: But the combine only tells teams how a player performs in a combine environment. (Which is tangential to your point, with the tangent heading towards the mysteries of testing rather than the wisdom of crowds.)

    Yes, but the hypothesis isn’t that the information is complete or all accurate (there’s always still risk!), it’s that all market participants have equal information, which in this case, is pretty close to true.

  35. 35
    Villago Delenda Est says:

    @Andrey:

    Think of how creationists insist “The second law of thermodynamics proves evolution is false!” – it’s not that the second law of thermodynamics is bullshit, it’s that they don’t understand the thing they’re trying to latch on to.

    Well, Creationists and Intelligent Design mavens do have one thing in common: They’re shitheads.

  36. 36
    Villago Delenda Est says:

    @Greg: What they actually do with the equal information is what makes things interesting. Which brings us to the topic of “rational actors”, a whole new area where economists explore exciting new nadirs of fail.

  37. 37
    Greg says:

    @Andrey:

    Think of how creationists insist “The second law of thermodynamics proves evolution is false!” – it’s not that the second law of thermodynamics is bullshit, it’s that they don’t understand the thing they’re trying to latch on to.

    Which reminds me: The new Cosmos show is AWESOME. I love how they explicitly take on this meme, and also the “human eye is too complex to have evolved” one, etc. The show makers clearly set out to debunk a lot of these common pieces of bullshit.

  38. 38
    Eric U. says:

    @KG: I have what I call the “human stupidity” theory of investing. Assuming other people are stupid with their money has worked pretty well for me when day trading. But it’s exhausting and time consuming. I’ve never really tried to scale it up to the point where I could make a living at it. If I could figure out how to short things with this theory, I’d really clean up, but the stupidity is too strong and there is too much market manipulation. Also doesn’t work as a long-term strategy, just a couple of days.

    All you have to do is read the yahoo investment boards to see that I’m on to something. So much emotion and irrational thinking. Too bad that sort of thing can’t be bottled, it has to be useful for something

    On the draft question, I assume Sam will be in the NFL next season, just not drafted. It will be telling if people with worse numbers and have been less accomplished get drafted though

  39. 39
    Belafon says:

    @Greg: There are those that think it’s too preachy, but I think it has to be: It’s a product of its time, which means it’s has to be a part of the battle against creeping fundamentalism.

  40. 40
    cmorenc says:

    @Richard Mayhew (quoting 538):

    The efficient-market hypothesis states that — with certain caveats — markets are informationally efficient. Since any one investor theoretically operates with the same set of information as any other,2 the EMH claims that no individual can consistently achieve risk-adjusted returns in excess of the market-wide average.

    This is no longer true of the stock market, as Michael Lewis convincingly explains in his new book “Flash Boys” about how a few big players (e.g. Goldman-Sachs) are profiting on having microsecond advance-information inside the market trading infrastructure that allows them to use automatic computerized trading to extract a small, but steady and riskless profit from each individual stock trade which cumulatively are staggeringly huge (many billions per year). To be clear this is the microsecond equivalent of profiting from insider information, completely aside from any brokerage trading fees they’ve made from providing any service to investors or the market. They have embedded themselves as parasites upon all ordinary stock-trading that goes on by everyone in the country.

  41. 41
    hoodie says:

    @Mnemosyne: There’s that, and the fact that the hard sciences only seem that hard to the really flaccid, like newspaper pundits. Economists are half-hard, at best. It amazes me that people can swallow that crap hook, line and sinker, but turn around and dismiss climate models as fairy tales. Last time I checked, tornadoes were pretty unemotional.

  42. 42
    🌷 Martin says:

    @Greg:

    Yes, but the hypothesis isn’t that the information is complete or all accurate (there’s always still risk!), it’s that all market participants have equal information, which in this case, is pretty close to true.

    Agreed. EMH works in select cases – typically cases where consumers are not involved. But in the billionaire monopoly that is pro sports, if a team owner doesn’t have equal information, then it’s his own damn fault. There are no structural impediments against equal information here.

  43. 43
    mattH says:

    @Seanly: There was a study years ago where they surveyed student’s attitudes at a University (but I repeat myself ;)) and broke them down into three groups, those having taken no econ classes, those having only had an intro class, and those who had multiple econ classes, and those who had only had intro exhibited the most conservative views. Intro to Macroecon seems almost designed to make people conservative.

  44. 44
    🌷 Martin says:

    @cmorenc:

    This is no longer true of the stock market,

    It was never true of the stock market. That’s why insider trading laws were put forward. What has made the stock market worse is actually the introduction of online trading in the early 90s that accompanied consumer access to the internet. That dramatically lowered the cost of entry by eliminating the costs associated with manually processing a trade by a broker. Once you had brokers and consumers in the same space, you inevitably had private information within the club and brokers and bankers could now exploit the information that consumers didn’t have. Then came the technological advantages like high speed trading, which is pretty minor relative to the bigger problems that preceded it.

  45. 45
    piratedan says:

    and no insider trading exists on Wall Street and let me tell you about the tooth fairy…..

  46. 46
    Trollhattan says:

    O/T Sun rises in west, experts puzzled.

    Rep. Darrell Issa, R-Vista, forcefully rebuked a controversial social media post by the gubernatorial campaign of Republican Tim Donnelly linking rival Neel Kashkari to fundamentalist Islamic law. Issa, a supporter of Kashkari’s bid to unseat Democratic Gov. Jerry Brown, said there is no place in public discussion “for this type of hateful and ignorant garbage.”

    “As far as I’m concerned, this type of stupidity disqualifies Tim Donnelly from being fit to hold any office, anywhere,” Issa said in a prepared statement Thursday. “Donnelly is no longer a viable option for California voters.”

    Donnelly apologized for the post Wednesday after being confronted by Kashkari adviser Aaron McLear on KSCO AM 1080 in Santa Cruz. His Facebook page had carried a link to a 2008 U.S. Treasury Department program in which Kashkari was listed as a speaker. The event was meant to help “inform the policy community about Islamic financial services, which are an increasingly important part of the global financial industry.”

    The dustup comes as an increasing number of establishment Republicans coalesce around the moderate Kashkari and distance themselves from Donnelly, a tea party favorite and former minuteman. With his high profile as chairman of the powerful House Oversight and Government Reform Committee, Issa stands to put the story on the national radar.

    http://blogs.sacbee.com/capito.....rylink=cpy
    I love the crunchy sound of Republicans eating their young.

  47. 47
    kindness says:

    Reminds me of Colbert’s repeating Fox last night:

    “That would be a great point if only it were true”.

    Colbert suggested Fox use it as their tag line.

  48. 48
    catclub says:

    @Trollhattan: ” Issa said there is no place in public discussion “for this type of hateful and ignorant garbage.”

    when it is aimed against my (Issa’s) allies.

  49. 49
    Villago Delenda Est says:

    @catclub:

    when it is aimed against my (Issa’s) allies.

    DING DING DING DING DING.

    When it’s aimed at the treasonous scum in the White House, the gloves are off!

  50. 50
    JPL says:

    @kindness: I can’t wait until I use that line.

  51. 51
    Origuy says:

    For Issa, it was personal as well. He’s of Lebanese descent. Of course, anti-Arab slurs would be ok if they were directed at Democrats.

  52. 52
    Rafer Janders says:

    @Gin & Tonic:

    Buffett, using fundamental analysis, has reliably produced excess returns. The “sample size” is everybody else.

    Well, maybe. He uses fundamental analysis, and he’s reliably produced excess returns, true. But it’s not necessarily true that he’s produced reliably excess returns BECAUSE of fundamental analysis — he may just be the one guy who got lucky. There are plenty of other managers who produced excess returns for years, even decades, and then suddenly ran dry (a la Peter Lynch at Fidelity). In the real world it’s hard to separate out talent from luck.

  53. 53
    Rafer Janders says:

    @chopper:

    with a few rare exceptions, Germany was a very peaceful country during the first half of the 20th century.

    Rather poor example, because in Germany’s case the peaceful time (about 1901-mid 1914) was actually the rare exception. After that, Germany spent about 35 of those 50 years in either war, civil war, revolution, political unrest, or foreign military occupation.

    The joke might have worked if you’d used, I dunno, Belgium? Holland?

  54. 54
    Yatsuno says:

    @Eric U.:

    On the draft question, I assume Sam will be in the NFL next season, just not drafted.

    I could see the Seahacks drafting him, but late. Carroll has taken pieces that others have not wanted and brought them into his program with success. To wit: Derrick Coleman. And Seattle wouldn’t be afraid of a gay player.

  55. 55
    Rafer Janders says:

    @different-church-lady:

    But the combine only tells teams how a player performs in a combine environment.

    Yes, but it tells ALL teams that, so in that case EMH works. EMH doesn’t posit that the information is necessarily complete or accurate or all-encompassing, just that all market participants are working with the same set of information.

  56. 56
    Mike G says:

    @Trollhattan:

    If stupidity and “hateful and ignorant garbage” disqualified someone from holding political office, Grand Theft Issa would be forced to make a living from stealing cars again.

  57. 57
    Villago Delenda Est says:

    @Rafer Janders: The point here is to mock the idiocy of the “rare exceptions” meme, not to illustrate literal exceptions.

  58. 58
    Rafer Janders says:

    @Villago Delenda Est:

    The point here is to mock the idiocy of the “rare exceptions” meme, not to illustrate literal exceptions.

    I get the point, but he used a really poor example to make that point. The mocking only works if you can come up with a country that had one spasm of violence that was so horrible that it overshadows an otherwise peaceful period, not a country that had 35 years of violence and unrest in a 50 year period.

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