On Justin Fox and the Efficient Markets Hypothesis

I saw a snippet of Justin Fox discussing his misleadingly titled book, 'The Myth of the Rational Market', and he continues to not admonish those who praise the book but haven't read it. Market Haynes summarizes the theory of efficient markets thusly:

One of the longest held economics theories is called the Efficient Markets Hypothesis, basically it says the market's always right...

That's just wrong. It is a straw man argument, like saying Republicans hate poor people, that Black-Scholes caused the failure of LTCM (Long-Term Capital Management), or that Value-at-Risk is a panacea: only naive critics say these things.

I think Fox may realize this, but I also think it is possible that amidst all his study, he doesn't really understand the ideas in play. After all, in that same interview, his big note of a regulatory reform that might help is Glass-Steagall, which is about as related to this crisis as the deregulation of Airlines (they both involved deregulation).

For in his book, he notes the failure of beta as related to the Efficient Markets Hypothesis (the EMH), but it is not clear how. I guess the nuance of the theory, how any test is a joint test of a market model and the EMH, is too subtle for either his audience, or Fox. For example, the CAPM (Capital Asset Pricing Model) could be true while the EMH false, and the EMH could be true and the CAPM false. So, tying the CAPM into his book is really confusing unless you explain why and how it failed.

I still like the book, which is much less tendentious than how presented in any of his TV appearances. But not as an exposition of the EMH debate, rather, as a supplement. There's good stuff in there, just don't expect to be clear on whether markets are efficient or not.

Comments

[Xyrus:]

What I'd like to see is a discussion on how one could tell the difference between an efficient market and an inefficient market with short and/or unpredictable inefficiencies.

I don't think that this is a black and white issue. In my opinion, there is a spectrum from efficient to inefficient. If inefficiences are short/random enough that it becomes difficult or impossible to take advantage of for 99.9999% of investors then there is really little difference between an efficient and inefficient market. However, if the inefficiencies are more predictable/longer lasting then it becomes more plausible that an investor can beat the market.

~X~

Jul 07 02:08 PM

[Ferdinand E...:]

Whoever said that Black-Scholes caused the failure of LTCM is totally ignorant and completely stupid. Please don't believe that. Myron Scholes is too smart to waste his time trying to use the B-S equation in a non-academic 'market situation', and Robert Merton - who, you remember knows more about equations like that than anyone in finance - is even smarter than Scholes.

As for all Republicans hating poor people , that is also wrong. On the average Republicans hate poor people, but in case you dont remember your statistics, since you are dealing with an average, there are probably some Republicans who like poor people better than a couple of Republicans...somewhere.

Jul 08 10:00 AM

[Glen L.:]

Sez here that a free market will always act rationally, but only in theory until such time as we actually have a free market. I don't know how anyone could make such a value judgment based on nonexistant empirical evidence, although one can generalize by saying the freer the market, the more prosperous, and if prosperity is a rational goal, free markets must be the right track.

As for Republicans hating poor people, two thoughts: first, there are plenty of poor Republicans (and more every day, thanks to this economy), and I doubt if they're self-hating; second, based on their pushing of the disastrous welfare-warfare state on the poor, and everyone else, the evidence suggests there are plenty of Democrats who hate poor people, including both poor Democrats and Republicans.

Collectivist thinking is stupid thinking, every time.

Jul 08 11:26 AM

[Gregman2:]

Isn't this theory also premised on the notion of equal access by all players to all pertinent information; and that disequilibria in markets ultimately self-recalibrate?;-) Sounds like the perfect self-regulating market. Can we just switch on auto-pilot and say good-bye to the regulators?

Jul 08 08:38 PM