TMFJake (60.34)

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August 03, 2009 – Comments (7)

From James Montier and Albert Edwards in a letter to the FT refuting Andrew Lo's argument on so-called "Adaptive Market Hypthesis" (the idea that markets are mostly rational except for brief periods of disequilibrium, which then results in market adaptation to return to rational balance):

As we understand it, the AMH provides a halfway house where sometimes markets are irrational and sometimes they are rational. We would argue that the amount of time that markets are rational is near negligible. Instead markets seem to be in a constant state of disequilibrium – moving from boom to bust and back again, rarely if ever stopping off at “normal”.

As one of us has recently argued (Insight, June 25), the efficient markets hypothesis is the financial equivalent of a dead parrot, then the AMH may be a dodo.

Actually, I'd say the current market is more of a labradoodle. Perhaps Schrodinger's Labradoodle.

7 Comments – Post Your Own

#1) On August 04, 2009 at 2:06 AM, guiron (21.45) wrote:

It's not that the market is irrational, it's that people are irrational. As long as the market allows mass stupidity to take hold, eventually it will. Pretty regularly, in fact.

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#2) On August 04, 2009 at 4:21 AM, FleaBagger (33.44) wrote:

Not a fan of Austrian theory, I'm guessing.

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#3) On August 04, 2009 at 9:57 AM, lemoneater (88.51) wrote:

Schrodinger's Labradoodle, love it :). The question remains are we seeing the head and shoulders of the labradoodle?

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#4) On August 04, 2009 at 10:04 AM, outoffocus (24.53) wrote:

The question remains are we seeing the head and shoulders of the labradoodle?

More like the dog chasing its tail.

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#5) On August 04, 2009 at 10:27 AM, StopLaughing (< 20) wrote:

AMH is an improvement over the EMH. However, I would suggest that the variables that cause markets to go up or down are so many and varied that the majority of the buying power tends to focus on one or more variables for a while and then switches to another set variables for a while.

The market drivers are more complicated and varied than the human mind can process all at one time. That takes a super computer with a reliable model.

What really happens is that the media try out various sets of causal relationships, much like throwing out ideas at the public. Whatever the public focuses on becomes the "explanation" of the short run. That focus is often wrong (driven by basic non cognitive motives) and is always incomplete.

What results is a "folk lore" explanation of how markets work and why they respond the way that they do. It is a construction of reality (after the fact) that can't capture reality.

If the majority of the buying power can't fathom the correct causals of the markets then the markets can not price properly.

However, the markets are usually better than Congress or a bunch of government bureaucrats deciding the value of all goods and services in a large economy.

Even if the market is unknowable I would rather (as a general rule) have the markets deciding prices than the government.

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#6) On August 24, 2009 at 11:04 AM, GraemesPSP (99.47) wrote:

I don't know the details about AMH, but the simple reason EMH doesn't work is because buying and selling of stocks (or other assets) are not symetrical. The potential universe of buyers is anyone who has heard of the stock. The potential universe of sellers is limited to those who currently hold the stock, and short sellers. Neither group of sellers can truly act as a the marginal seller assumed by EMH. Current stock holders have an inbuilt bias towards the stocks they own, that is why they bought those particular stock as opposed to any other ones in the first place. And short sellers are a relatively small group, who are constrained due to the risks in shorting and the need for risk management when shorting a position - markets can stay irrational for longer than you can stay solvent being the operative philosphy.

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#7) On August 26, 2009 at 1:13 PM, TMFJake (60.34) wrote: