Why The Efficient Market Hypothesis Is Useless

May 27, 2015 8:44 AM ET66 Comments
Cullen Roche profile picture
Cullen Roche

I noticed Noah Smith and John Authers on Twitter discussing how great the Efficient Market Hypothesis is because it explains why indexing works. I responded saying that the EMH really has nothing to do with why indexing works. They didn't seem to see my point of view so let's try this again and see if we can finally get this industry on a path towards understanding how incredibly silly the EMH actually is.

The original EMH stated that markets priced information efficiently. That is, if some news was released the markets would price this so that it was incredibly difficult to take advantage of this new information. This was basically a way of saying that markets work better than people who intervene in a discretionary manner. It's not surprising that this idea was largely developed by the Chicago School of Economics during the period of Milton Friedman's reign of terror because this established a theory of finance that was consistent with a theory of economics that was inherently anti government (interventionist).

Since then, the theory of economics has basically collapsed as it's been proven largely false. Monetarism, as it was originally constructed, is no longer taken very seriously. But the theory of finance has been heralded as a great success. The banner has been carried triumphantly by Eugene Fama and others. The problem is that this theory is also collapsing (though much, much more slowly). When Fama realized that there was some unexplained outperformance in certain types of assets he had to change the EMH. EMH went from being a strong form to a semi strong to a weak form. And his factor models evolved from one factor to three to five and now there are even hundred factor versions. The original EMH is a mere shadow of its former self and no one finds it all that useful. For some reason it is

This article was written by

Cullen Roche profile picture
Mr. Roche is the founder of Discipline Funds, a provider of multi-asset low cost ETFs and financial advisory services. To learn more about Discipline Funds please see:https://disciplinefunds.com/

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