# Efficient market hypothesis



## profithunter (24 July 2004)

Who agrees with this hypothesis??

I'm interested to know as I recently completed an essay on the subject.


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## PurePA (7 July 2014)

I’d say that Efficient market hypothesis holds true only in very liquid markets for a very short periods of time, but has no validity over longer time periods. People are not efficient when it comes to decision making and the markets are full of people who make irrational decisions.


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## luutzu (7 July 2014)

profithunter said:


> Who agrees with this hypothesis??
> 
> I'm interested to know as I recently completed an essay on the subject.




Of the three forms of the EMH, all three are equally useless.

The only use is for Portfolio Management students like myself, who slack off all semester and in the last hours, put together a portfolio modeled on the EMH and its Random Walk, monkey throwing darts.... and simply say i throw darts and select these stocks, the portfolio has performed such and such versus the index. Hands in the essay, pass the course


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## skc (8 July 2014)

profithunter said:


> Who agrees with this hypothesis??
> 
> I'm interested to know as I recently completed an essay on the subject.




The hypothesis is just that. It is useful in explaning certain situations. It is also useful as a sanity check against your own investment assumptions etc.

A simple illustration is this... EMH would suggest that you'd never find a $100 note sitting in the middle of a busy footpath...because someone else would have picked it up already. Clearly, EMH didn't apply to that "someone" who happened to pick it up.

At the same time, if you build a buisness plan around picking up $100 notes on footpaths, EMH suggests you won't be too profitable. So it'd be correct in this instance.


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## Value Collector (8 July 2014)

Years ago Warren Buffet wrote a rebuttal to the efficient market hypothesis, Mainly because the proponents of it at the time were saying Warrens fabulous long term record is due to luck, not skill.

Here is the rebuttal, its actually a good read. it's 13 pages, but its freezing outside, So make a Milo and enjoy 

http://www4.gsb.columbia.edu/null?&exclusive=filemgr.download&file_id=522

http://www4.gsb.columbia.edu/null?&exclusive=filemgr.download&file_id=522


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## DeepState (8 July 2014)

Please find attached the 'factor return' from Ken French for 'VALUE' (it is known as HML - High minus Low) and represents the return on a self funding long-short portfolio which is long stocks with low P/B and short the converse after controlling for certain other factors.  This is not exactly what Buffett was referring to, but is in line with the concept of investing with a value tilt and this producing sustained profits over time (albeit that the concept is having a bit of a rest lately).  It is entirely a different matter as to whether this chart actually supports or refutes EMH.

In my view, EMH is an artificial construct for laboratory purposes - much as CAPM, MPT, Neo-Keynesian economics...just don't tell Gene Fama.


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## luutzu (8 July 2014)

Value Collector said:


> Years ago Warren Buffet wrote a rebuttal to the efficient market hypothesis, Mainly because the proponents of it at the time were saying Warrens fabulous long term record is due to luck, not skill.
> 
> Here is the rebuttal, its actually a good read. it's 13 pages, but its freezing outside, So make a Milo and enjoy
> 
> ...




I think in one of his BRK letters, Buffett was joking that maybe he and other disciples of Graham should consider funding courses that teach the EMH -  not because of its merits, but because it will produce weak competitors who were taught there's no use trying.


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## luutzu (8 July 2014)

DeepState said:


> Please find attached the 'factor return' from Ken French for 'VALUE' (it is known as HML - High minus Low) and represents the return on a self funding long-short portfolio which is long stocks with low P/B and short the converse after controlling for certain other factors.  This is not exactly what Buffett was referring to, but is in line with the concept of investing with a value tilt and this producing sustained profits over time (albeit that the concept is having a bit of a rest lately).  It is entirely a different matter as to whether this chart actually supports or refutes EMH.
> 
> In my view, EMH is an artificial construct for laboratory purposes - much as CAPM, MPT, Neo-Keynesian economics...just don't tell Gene Fama.
> 
> View attachment 58605




Just googled and it seems $1 invested in the S&P500 in 1940 returns around $1,000 in 2010. So that might support the EMH. 

However, though haven't read the study you're referring to so don't know how they construct the portfolio, e.g. do they short as in bet against high P/B stocks or just ignore it? But the long-short portfolio as an argument, either for or against the EMH, seems a case of straw-manning the value/fundamental investor.

I think investor not throwing darts look at other things than just P/B.

A good essay showing anecdotal evidence against the EMH was Super Investors of Graham Town and Doddsville [by Buffett?] - where he show how Graham and his students, like Buffett, Walter Schloss, Ruane [founder of Sequoia ?] all managed annual returns of 20% + over the decades and all did it through owning different companies/stocks. The only similarities in their approach was they followed the teachings of Graham and Dodd.


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## So_Cynical (8 July 2014)

Efficient market hypothesis = similar to a broken clock that's right once per day, just not every stock on every day.


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## luutzu (8 July 2014)

skc said:


> The hypothesis is just that. It is useful in explaning certain situations. It is also useful as a sanity check against your own investment assumptions etc.
> 
> A simple illustration is this... EMH would suggest that you'd never find a $100 note sitting in the middle of a busy footpath...because someone else would have picked it up already. Clearly, EMH didn't apply to that "someone" who happened to pick it up.
> 
> At the same time, if you build a buisness plan around picking up $100 notes on footpaths, EMH suggests you won't be too profitable. So it'd be correct in this instance.




That's a good point.

I bought this company that the market doesn't seem to like very much even though I think it's still quite an amazing business. So loaded up on it. But every now and then the market brought it down, then up, then down to levels at or slightly below what I bought... and not disrespecting the market, each time it drop drastically, I get nervous and check and recheck my calculations and understanding and search for new developments... so yea, does make you think and recheck your sanity.

---
Was listening to this lecture on maths and logic a while back and an example they gave with regards to logic, and they did say logic, was that if Bill Gates find a $100 note, should he pick it up... is it worth his while to pick it up?

That since he's worth billions, earn hundreds of thousands an hour [or whatever it worked out to be], and so earns thousands per second... and if it take him 2 second to bend over and pick up the $100 note, he should NOT pick it up because mathematically and logically he earns more than $100 a second and wasting 2 seconds on $100 is not worthwhile and Gates ought to walk over it.

It's a good example of maths being illogical. That if Gates earn $x per year, divide that by 365 days, by hours, by minutes, by seconds and you come to a nice round earnings per second. To then apply that precise figure without really thinking about it will make Gates $100 poorer. That is, Gates earn $x per year already, no matter what else he does.. and so him picking up an extra $100 is sensible and make him $100 richer, not losing thousands.


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## ROE (9 July 2014)

Seven and nexus deal clearly indicate the market isn't efficient 

They rather go down the toilet than take a low ball offer from Seven

The market will be efficient if it run by robots but once you have human involve
it changes everything.

most human cant control greed, fear, and fore father survival instinct run with the herd for safety


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## DeepState (9 July 2014)

luutzu said:


> 1. Just googled and it seems $1 invested in the S&P500 in 1940 returns around $1,000 in 2010. So that might support the EMH.
> 
> 2. However, though haven't read the study you're referring to so don't know how they construct the portfolio, e.g. do they short as in bet against high P/B stocks or just ignore it?
> 
> ...




1. It doesn't say anything about EMH.

2. Pls refer to the original post you are commenting on.

3. It isn't.

4. Naturally.


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## luutzu (9 July 2014)

DeepState said:


> 1. It doesn't say anything about EMH.
> 
> 2. Pls refer to the original post you are commenting on.
> 
> ...





1. Could be use to say something about EMH: That a portfolio was constructed through research (look for P/B ratio and act accordingly, rather than merely invest in an index, and has returned much lower than the general market over time);


3. If the long-short portfolio model WERE to be used as an example of not indexing, not believing in EMH... then that's can be seen as saying, see, the Buffett wanna-be thought they could beat the market... and them value hunters look at price to book stocks and look what that brought them.

4. Was used to support point made in 3.


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## DeepState (9 July 2014)

ROE said:


> The market will be efficient if it run by robots but once you have human involve
> it changes everything.




This is a really interesting point and goes to the heart of the issue.  Robots beat humans in Chess.  We cannot, as a species, win at this game vs machines anymore over time.  Chess has fixed rules.  There is no randomness in the game.

Consider poker.  Robots do not win here.  The game is different.  Why?  Certain 'illogical' moves need to be made to win and there is randomness.  Logic does not dominate despite the fact that all players have access to the same information (except for their hole cards).  Bluffs and plays evolve all the time and adapt.  The top players keep appearing at the final's table.  This is evidence of skill.

In the above, logical, cold, calculating, robots do well. They have access to all the information available (ie. more or less informationally equivalent as per EMH at each level), they are optimisers (Perform as per logic would dictate as per EMH).  But they do not win with any consistency.

The nature of financial markets is much closer to poker than chess.  The foundation of EMH was based on equivalence of information and optimal use of that information by a set of uniform, robotic, automatons that made up the market.  Playing poker with robots. Always a high standard game where the winning robot was very random.  That was until, at 2:14 a.m. Eastern time, August 29th 1997, Skynet became self-aware and the whole game changed for good. 

EMH describes a pretend world whose rules and set-up do not match our reality. That said, many of the key propositions remain valid (the average of poker players lose after the various takes are removed from the buy-ins, those of average skill randomly mill about it rankings).  In my view, however, the path taken to get to those propositions is more accurately described by other methods not involving the strict and unrealistic ones embedded in EMH.  This is important because it helps us to figure out how to sustainably reach that finals table.  We observe that to be true (also there are sustainably successful investors as an analog) whilst EMH cannot countenance its existence.


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## DeepState (9 July 2014)

luutzu said:


> 1. Could be use to say something about EMH: That a portfolio was constructed through research (look for P/B ratio and act accordingly, rather than merely invest in an index, and has returned much lower than the general market over time);
> 
> 
> 3. If the long-short portfolio model WERE to be used as an example of not indexing, not believing in EMH... then that's can be seen as saying, see, the Buffett wanna-be thought they could beat the market... and them value hunters look at price to book stocks and look what that brought them.




1.The portfolio shown was long-short.  It has no gross market exposure. You compare this to a long only index portfolio and want to say that it says something about EMH?  All the best.

3.  The return to SML may or may not be driven by the tenants of EMH.  The core of the debate has no names attached to the returns generated or wannabes looking for their autographs.  There is no straw man. The debate would exist even in Buffett did not exist.  There is an observation that this takes place.  Certain explanations have to be true for EMH to be supported.  It is arguable that it is supported, but there are very strong arguments that this is not entirely true. A rising SML doesn't mean anything for EMH on its own.


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## luutzu (9 July 2014)

DeepState said:


> 1.The portfolio shown was long-short.  It has no gross market exposure. You compare this to a long only index portfolio and want to say that it says something about EMH?  All the best.
> 
> 3.  The return to SML may or may not be driven by the tenants of EMH.  The core of the debate has no names attached to the returns generated or wannabes looking for their autographs.  There is no straw man. The debate would exist even in Buffett did not exist.  There is an observation that this takes place.  Certain explanations have to be true for EMH to be supported.  It is arguable that it is supported, but there are very strong arguments that this is not entirely true. A rising SML doesn't mean anything for EMH on its own.




I'm pretty sure i understand what you meant by the long-short portfolio, that, as you said, buy stocks with low P/B and sell [short] those with high P/B and the results is in the chart you provided: Return from US Equity for that long-short portfolio where $1 invested now return $100.

Like I said, I haven't read that research and so my understanding could be wrong. 

But if it is right, a chart I saw on returns on S&P500 over similar timeframe was 1 to 1000. ... ahhh... OK, got you.


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## DeepState (9 July 2014)

luutzu said:


> I'm pretty sure i understand what you meant by the long-short portfolio, that, as you said, buy stocks with low P/B and sell [short] those with high P/B and the results is in the chart you provided: Return from US Equity for that long-short portfolio where $1 invested now return $100.
> 
> Like I said, I haven't read that research and so my understanding could be wrong.
> 
> But if it is right, a chart I saw on returns on S&P500 over similar timeframe was 1 to 1000. ... ahhh... OK, got you.




You just got your Pass re-stated to HD.


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## luutzu (10 July 2014)

DeepState said:


> You just got your Pass re-stated to HD.




awesome. Could finally use those gold star stickers


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## KnowThePast (13 July 2014)

In my opinion, EMH holds true for most stocks, most of the time. But there are times/stocks when it is clearly wrong.

You can wait for those opportunities and bet big.

Or you can hold a more diversified portfolio and skew it towards where you think it is more likely to be ineffcient. 

The second will be closer to average performance, but protects from you from mistakes on large bets.


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