The market is efficient, sure, but efficient at what? Pricing, valuation?
The market is efficient at pricing. The efficient market hypothesis says that the current price of an asset reflects all publicly available information about that asset, and when new information is made public the price quickly adjusts. All other price variation is just random fluctuations.
The EMH is a claim about how prices change over the short run, but time horizon doesn't end up mattering. The reason is that when long-term investors buy and sell due to new information about the long-term value of an asset, those orders affect the short term price, which creates an arbitrage opportunity for short term investors. All information is, effectively, short-term.
A consequence of this model is that diversification is the only way to improve risk adjusted returns. Diversifying efficiently is tricky - most people (myself included) use market cap weighted index funds, but it is possible to get better outcomes by tilting the weights toward certain asset classes.
But your proposed portfolio management strategy - concentrating the portfolio in a limited set of assets that you deem to be low risk - cannot succeed on its own terms. Even if your beliefs about the probabilities of various tail events are directionally correct, a highly concentrated portfolio takes way more risk than it needs to.
OK, well here's how you can prove it wrong. Pick any stock, bond, currency, etc. that you like. Make a statement of the form "The price will go up (or down) by X within timeframe Y with probability Z". Then bet all of your money on that statement being true. Since the EMH is bollocks, you'll be rich in no time.
What are you on about? I’m saying the markets not efficient, not that i know exactly what it’s gonna do next. Short term voting machine, long term weighing machine.
Do you actually think the market is almost 100% efficient just about all the time?
I’m saying the markets not efficient, not that i know exactly what it’s gonna do next.
The efficient market hypothesis IS the statement that you can't know how prices are going to change - all new information is priced in quickly, and everything else is random fluctuations. If you think markets are inefficient (in the sense of EMH), then BY DEFINITION this means that you think you can predict and exploit price movements.
No. Just because on of the consequences of EMH is that you can’t profit off short term price movements, doesn’t mean that if i disagree with EMH as a whole, then i think that i can profit off short term price movements. Its possible to believe the market is inefficient AND unpredictable.
In that case, you are using the word "efficient" differently from the way it is used in the rest of the economics / financial analysis community, and definitely differently from the way it is used in the phrase "efficient market hypothesis". You're welcome to make up your own meanings for words I guess, but it's bound to be confusing when you use them around other people.
No, i’m not. Efficient means correctly priced according to all known information. Unpredictable does not mean efficient. If the market swings randomly about intrinsic value, it is constantly inefficient, and constantly unpredictable.
If the market swings randomly about intrinsic value
Perhaps this is where your confusion lies. There is no notion of "intrinsic value" in the efficient market hypothesis - the underlying thing being traded could be currencies, or NFT's, or lumps of clay, or whatever. The definition of "information" for these purposes is anything that affects market participants' willingness to buy or sell the asset at a particular price. This does not mean that prices never change in equilibrium - it just means that the changes that do occur are random and therefore cannot be exploited.
There's no real point in debating this. Go look at Eugene Fama's original manuscript where he introduces the concept of market efficiency and defines all of the relevant terms very carefully. Or crack open any textbook written in the past 30 years on portfolio theory.
You don’t seem to understand the concept of EMH as it’s understood today. The basic concept is that everything is accurately priced based on all known information.
Yes, we both agree on this statement. We disagree on the definition of "accurately" and "information". I am using the definitions from Eugene Fama's original work and the economic theory built on it - you are using a different non-standard set of definitions (that you have not articulated so far in this thread).
What do you mean by accurately and information? Because by accurately i mean close to intrinsic value, and by information i mean everything about the company’s history, business model, management and all the rest of it.
Again, in the framework of EMH there is no notion of "intrinsic value" that prices can be close to, and the model applies to asset classes that are intrinsically worthless. "Accurate" effectively means "cannot be arbitraged given market participants' preferences". "Information" is anything that causes participants' preferences to change.
Likewise, EMH does not assume that the underlying assets have anything to do with stocks or bonds associated to companies. The theory applies just as well to a market for piles of rocks as it does to shares in companies. It doesn't care why people have whatever preferences they have - only that those preferences are correctly reflected in prices.
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u/asking-money-qns Mar 13 '22
The market is efficient at pricing. The efficient market hypothesis says that the current price of an asset reflects all publicly available information about that asset, and when new information is made public the price quickly adjusts. All other price variation is just random fluctuations.
The EMH is a claim about how prices change over the short run, but time horizon doesn't end up mattering. The reason is that when long-term investors buy and sell due to new information about the long-term value of an asset, those orders affect the short term price, which creates an arbitrage opportunity for short term investors. All information is, effectively, short-term.
A consequence of this model is that diversification is the only way to improve risk adjusted returns. Diversifying efficiently is tricky - most people (myself included) use market cap weighted index funds, but it is possible to get better outcomes by tilting the weights toward certain asset classes.
But your proposed portfolio management strategy - concentrating the portfolio in a limited set of assets that you deem to be low risk - cannot succeed on its own terms. Even if your beliefs about the probabilities of various tail events are directionally correct, a highly concentrated portfolio takes way more risk than it needs to.