“One can search economic textbooks forever without finding a concept called ‘jobs saved’,” said Allan Meltzer, a professor at Carnegie Mellon University, in a memo to House of Representatives Republican leader John Boehner today. “How can anyone know that his or her job has been saved?”
For the complete article see here.
Saturday, October 31, 2009
Portfolio Theory and Asset Pricing - Blatant Marketing
Please consider enrolling in Portfolio Theory and Asset Pricing [BA620 7:00-10 pm]; the class is offered Monday/Wednesday beginning 01/21/09. I have a preliminary syllabus which I can e-mail to you. The materials are already ready from Harvard. The course is now listed on course finder http://www.uaf.edu/coursefinder/
Joint Hypothesis Problem in Finance
We cannot test for market efficiency. Why you ask?
1) One needs a measuring stick against which abnormal returns can be compared;
2) We do not know if the market is efficient IF we do NOT know that a model such as the CAPM, APT or the Black-Scholes model correctly stipulates the required rate of return. (Again, we have no measuring stick.)
Therefore, we must conclude either the asset pricing model is incorrect or the market is inefficient, but we have no way of knowing which is true.
1) One needs a measuring stick against which abnormal returns can be compared;
2) We do not know if the market is efficient IF we do NOT know that a model such as the CAPM, APT or the Black-Scholes model correctly stipulates the required rate of return. (Again, we have no measuring stick.)
Therefore, we must conclude either the asset pricing model is incorrect or the market is inefficient, but we have no way of knowing which is true.
Friday, October 30, 2009
Michael Gibbs on 'the invisible hand' and Hayek
The post below is from Michael Gibbs at the University of Chicago.
"....Smith's Invisible Hand notes the paradox that selfish individuals acting in their own interest create great overall social value (economic growth, low DWL, etc.) in market economies. One very important insight into how markets do this is to view a market as an *information system* that provides collective intelligence. Friedrich von Hayek won a Nobel for first making this argument (yes, he spent part of his career at Chicago). You can easily find the article on the web; here is a brief summary.
Hayek argued that markets are a powerful way to make use of "specific knowledge of time and place" dispersed throughout the economy. A farmer uses his experience & talent at farming, knowledge of local soil conditions & weather, etc. to maximize the value of his land. He also has good incentives to do so - or to sell it to someone who can use it better - b/c he owns the land & the profits from it. Hayek argued that markets, because they are decentralized, use this dispersed knowledge that central planners would not be able to use, and thus allocate resources more effectively than more centralized economies - yielding the Invisible Hand.
Hayek's argument is hugely insightful and important. He teaches us to view markets as a giant information system, and highlights that one of if not the most important problems that an economic system must solve is to create and use knowledge effectively."
"....Smith's Invisible Hand notes the paradox that selfish individuals acting in their own interest create great overall social value (economic growth, low DWL, etc.) in market economies. One very important insight into how markets do this is to view a market as an *information system* that provides collective intelligence. Friedrich von Hayek won a Nobel for first making this argument (yes, he spent part of his career at Chicago). You can easily find the article on the web; here is a brief summary.
Hayek argued that markets are a powerful way to make use of "specific knowledge of time and place" dispersed throughout the economy. A farmer uses his experience & talent at farming, knowledge of local soil conditions & weather, etc. to maximize the value of his land. He also has good incentives to do so - or to sell it to someone who can use it better - b/c he owns the land & the profits from it. Hayek argued that markets, because they are decentralized, use this dispersed knowledge that central planners would not be able to use, and thus allocate resources more effectively than more centralized economies - yielding the Invisible Hand.
Hayek's argument is hugely insightful and important. He teaches us to view markets as a giant information system, and highlights that one of if not the most important problems that an economic system must solve is to create and use knowledge effectively."
Thursday, October 29, 2009
Paper by Andy Lo on 'Adaptive Markets'
An interesting article by Andy Lo on reconciliation of the EMH with behavioral finance. h/t Simoleon Sense. Click here to download paper.
Reconciling Efficient Markets with Behavioral Finance: The Adaptive Markets Hypothesis
Andrew W. Lo
MIT Sloan School of Management; National Bureau of Economic Research (NBER)
Journal of Investment Consulting, Forthcoming
Abstract:
The battle between proponents of the Efficient Markets Hypothesis and champions of behavioral finance has never been more pitched, and there is little consensus as to which side is winning or what the implications are for investment management and consulting. In this article, I review the case for and against the Efficient Markets Hypothesis, and describe a new framework - the Adaptive Markets Hypothesis - in which the traditional models of modern financial economics can co-exist alongside behavioral models in an intellectually consistent manner. Based on evolutionary principles, the Adaptive Markets Hypothesis implies that the degree of market efficiency is related to environmental factors characterizing market ecology such as the number of competitors in the market, the magnitude of profit opportunities available, and the adaptability of the market participants. Many of the examples that behavioralists cite as violations of rationality that are inconsistent with market efficiency - loss aversion, overconfidence, overreaction, mental accounting, and other behavioral biases - are, in fact, consistent with an evolutionary model of individuals adapting to a changing environment via simple heuristics. Despite the qualitative nature of this new paradigm, I show that the Adaptive Markets Hypothesis yields a number of surprisingly concrete applications for both investment managers and consultants.
Keywords: Efficient markets, behavioral finance, adaptive markets
Efficient Market Hypothesis Revisited
The efficient market hypothesis came about primarily through the work of one man - Eugene Fama. Gene graduated with his doctoral degree at the University of Chicago in the 60s and along with colleagues at Chicago and MIT, the efficient market hypothesis evolved. Listen to Gene explain it's birth here. Listen to Gene talking about the financial crisis and market efficiency here.
This year there has been much discussion regarding the role of "efficient market theory "or the "efficient market hypothesis (EMH)" causing the financial meltdown. As any economist, worth his salt, knows the charge merits on the ridiculous.
Let's quickly review the EMH.
EMH assumes:
1) Utility maximizing agents; and
2) Agents with rational expectations.
Agents need not be rational. When faced with new information, some investors may overreact and some may under-react. All that is required by the EMH is that investors' reactions be random so that the net effect on market prices cannot be reliably exploited to make an abnormal profit, especially when considering transaction costs (including commissions and spreads).
Thus, any one person can be wrong about the market — indeed, everyone can be wrong — but the market as a whole is always right.
There are three puzzling aspects in regard to the EMH
This year there has been much discussion regarding the role of "efficient market theory "or the "efficient market hypothesis (EMH)" causing the financial meltdown. As any economist, worth his salt, knows the charge merits on the ridiculous.
Let's quickly review the EMH.
EMH assumes:
1) Utility maximizing agents; and
2) Agents with rational expectations.
Agents need not be rational. When faced with new information, some investors may overreact and some may under-react. All that is required by the EMH is that investors' reactions be random so that the net effect on market prices cannot be reliably exploited to make an abnormal profit, especially when considering transaction costs (including commissions and spreads).
Thus, any one person can be wrong about the market — indeed, everyone can be wrong — but the market as a whole is always right.
There are three puzzling aspects in regard to the EMH
- Momentum or persistence - "sorting stocks on past returns shows a tendency in the short-run for the best performers to continue to perform well and for the worst performers to continue to perform poorly" (Japan appears to be immune from momentum)
- Post-earnings announcement persistence
- 'Excess' volatility in prices in the short-run
1) Future prices cannot be predicted by analyzing prices from the past.
2) Excess returns can not be earned by using investment strategies based on historical share prices or other historical data. (example, technical analysis)
3) Share prices show no serial dependencies (no "patterns" to asset prices).
1) Share prices adjust to publicly available new information very rapidly and in an unbiased fashion; no excess returns can be earned by trading on that information.
1) Share prices reflect all information, public and private, and no one can earn excess returns. If there are legal barriers to private information becoming public, as with insider trading laws, strong-form efficiency is impossible, except in the case where the laws are universally ignored. (Insiders do better - about 1% on their transactions)
Blog's Purpose
The blog will be used in conjunction with the classes I teach. It will expand on questions of the day as well as topics we cover in class.
If you need to reach me you can at 512-468-4550 or at wmarr2@gmail.com. For now, the blog will be minimal. I will expand as I have time.
wayne marr
If you need to reach me you can at 512-468-4550 or at wmarr2@gmail.com. For now, the blog will be minimal. I will expand as I have time.
wayne marr
Subscribe to:
Posts (Atom)
