Re: Marxist Fianancial Advice

[Daniel Davies <dsquared@xxxxxxxxxxxxxxxx>]

Peter has it right.  Fama's 3 kinds of market efficiency are basically
statistical definitions; they're different strengths of assertions about
unpredictability.  This is a necessary condition for efficiency (viz the
title of Samuelson's paper on the subject "Properly Anticipated Prices
Fluctuate Randomly") but not sufficient.  The more hazy idea behind
efficient markets theory is that stock market prices are in some way the
"best" forecast of discounted value of future cash flows.  This is
particularly problematic as it is not at all obvious (to me anyway) that the
"best" forecast is identical with the "most accurate" one in any relevant
sense; it seems to me that there's no basis for the assumption that someone
making estimates of future cashflows would judge forecasting systems using a
mean-squared error criterion, or even an unbiased loss function.

There is in fact a decent Hayekian argument to be made that it's a gross
misunderstanding of the nature of markets as information processing entities
to assume that you can read information out of the prices and treat it as
information (in particular, I think that Hayek's critique of planning rules
this out).  The prices on the stock ticker are epiphenomena of the process
which markets exist to carry out; the provision of liquidity to rentiers.

dd

-----Original Message-----
From: PEN-L list [mailto:PEN-L@xxxxxxxxxxxxxxxx]On Behalf Of Peter
Dorman
Sent: 23 June 2004 20:13
To: PEN-L@xxxxxxxxxxxxxxxx
Subject: Re: Marxist Fianancial Advice


I did a brief review of this lit for a paper I wrote recently.  Some
comments:

1. If market efficiency has any substantive relationship to "real"
factors (as revealed ex post), unpredictability of price movements is
necessary but not sufficient for efficiency.

2. The only defensible claim about financial markets is that they are
unpredictable in the their first moment (directionality).  Schiller et
al., as well as common sense, suggest that the higher moments
(overshooting) are predictable.  This is just another way of saying that
an informed observer (like Doug) can tell you when the market is over-
or undervalued (with better than 50% probability) but not when to get
out or in.

3. If people make consistent errors of judgment (there is lots of
evidence that they do), today's price could always be the best estimator
of tomorrow's and yet the market would be inefficient according to some
objective standard.  In other words, both today's price and tomorrow's
can be irrational.

None of this is very profound, but sometimes the semantics of this topic
obscures the more-or-less simple underlying concepts.

Peter

Doug Henwood wrote:

> Devine, James wrote:
>
>> BTW, the stock market is basically unpredictable _even though_ it
>> doesn't fit the "efficient markets" hypothesis.
>
>
> Again, I must turn into a pedant and ask just what you mean by that.
> There are several forms of the EMH. Quoting myself from Wall Street,
> characterizing Eugene Fama's review:
>
>> Fama distinguished among three varieties of the EMH: the weak,
>> semi-strong, and strong forms. The weak form asserts that the past
>> course of security prices says nothing about their future
>> meanderings. The semi-strong form asserts that security prices
>> adjust almost instantaneously to significant news (profits
>> announcements, dividend changes, etc.). And the strong form asserts
>> that there is no such thing as a hidden cadre of "smart money"
>> investors who enjoy privileged access to information that isn't
>> reflected in public market prices.
>
>
> This isn't entirely nonsense, is it? Would you argue that stock
> prices don't adjust almost instantaneously to fresh news? Would you
> argue that there isn't a strong element of randomness in prices? If
> you say the market is basically unpredictable, then you're
> subscribing to at least part of the EMH.
>
> The anomalies that have been identified over the years - that low P/E
> stocks outperform high P/E ones, for example - imply that stocks are,
> at least to some degree, predictable. The same with Shiller's work on
> overreaction, which implies that speculators who bet against extremes
> of mob psychology (which is essentially the strategy of both Keynes
> and Soros) are part of a smart money cadre that aren't trading on the
> basis of nonpublic information, but on an unpopular analysis.
>
> You could say that the market efficiently reflets the often
> nonsensical consensus of investors, which is something EMH types
> wouldn't agree with. Even some dissidents have a problem with
> irrationality. The first time I met Joseph Stiglitz was late in the
> dot.com mania. I was very curious to hear his analysis of that
> lunacy. But his info theory still holds that investors are rational,
> just not all equally informed. So he wondered aloud, "Why do people
> buy those stocks?"
>
> Doug