Actually, realizing this parallel causes me to be even more dubious of the efficient market hypothesis.
As compelling as it may sound when you say it, this line or reasoning plainly doesn’t work in scientific truth… so why should it work in finance?
Behavioral finance gives us plenty of reasons to think that whole markets can remain radically inefficient for long periods of time. What this means for the individual investor, I’m not sure. But what it means for the efficient market hypothesis? Death.
The thing to keep in mind is that a perfectly efficient market is like an ideal gas. It’s a useful tool for thinking about what’s likely to happen if you go messing with variables, but it basically never actually exists in nature.
We use markets in real life not because they’re perfect, but because, on average, they get a more correct answer more often and for less effort than any other system we know of.
Could there be something better? Of course. We just haven’t discovered it yet.
Are there situations where, in hindsight, we can see that some other system would have performed better than a market? Yup. Hindsight’s awesome that way.
Can we predict well in advance when to use some other system? Not particularly. And if we could then that ability would become part of the market, so the market would still be likely to perform better when used globally.
So yeah, markets can remain horribly inefficient for a long time under some circumstances. Just remember that the same things that keep a market inefficient will likely also cause mistakes by other methods of calculation. So when you switch away from the market you’re basically going double-or-nothing and the odds generally aren’t in your favor.
Actually, realizing this parallel causes me to be even more dubious of the efficient market hypothesis.
As compelling as it may sound when you say it, this line or reasoning plainly doesn’t work in scientific truth… so why should it work in finance?
Behavioral finance gives us plenty of reasons to think that whole markets can remain radically inefficient for long periods of time. What this means for the individual investor, I’m not sure. But what it means for the efficient market hypothesis? Death.
The thing to keep in mind is that a perfectly efficient market is like an ideal gas. It’s a useful tool for thinking about what’s likely to happen if you go messing with variables, but it basically never actually exists in nature.
We use markets in real life not because they’re perfect, but because, on average, they get a more correct answer more often and for less effort than any other system we know of.
Could there be something better? Of course. We just haven’t discovered it yet.
Are there situations where, in hindsight, we can see that some other system would have performed better than a market? Yup. Hindsight’s awesome that way.
Can we predict well in advance when to use some other system? Not particularly. And if we could then that ability would become part of the market, so the market would still be likely to perform better when used globally.
So yeah, markets can remain horribly inefficient for a long time under some circumstances. Just remember that the same things that keep a market inefficient will likely also cause mistakes by other methods of calculation. So when you switch away from the market you’re basically going double-or-nothing and the odds generally aren’t in your favor.