How do Bogleheads reconcile efficient markets theory with Bitcoin?

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Caduceus
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How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by Caduceus » Fri Jan 19, 2018 8:19 pm

Lots of people on this board seem to believe in a fairly strict version of EMH. How does Bitcoin fit into this view of the investing world?

Is Bitcoin fairly valued by the market at every moment? Has Bitcoin been fairly valued over the last month or year? How do you reconcile these things?

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by jfn111 » Fri Jan 19, 2018 8:21 pm

I'll be honest. I don't understand bitcoin and I can't reconcile it with anything. :oops:

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by Caduceus » Fri Jan 19, 2018 8:27 pm

You know, the people who have bought into Bitcoin are the same groups of investors (hedge funds, institutions, the general public) who buy the companies in the index fund. It's the exact same pricing/valuation mechanism.

Wouldn't it be more consistent for the Bogleheads who insist that "we don't know more than the market" to then also accept that perhaps Bitcoin is fairly valued?

Or alternatively, to accept that investors can be extremely irrational or emotion-driven, and that the efficient markets theory may not be an accurate description of the investment universe?

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by bberris » Fri Jan 19, 2018 8:31 pm

The version of EMT that I subscribe to says that public information cannot be used to predict future prices or beat the average without taking extra risk. I see nothing in bitcoin history to disprove that. I don't believe that EMT says that markets are "right" or "fair", those words being undefined.

I might make an exception for momentum, which appears to be real, although it might simply be adding risk.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by mws13 » Fri Jan 19, 2018 8:34 pm

Caduceus wrote:
Fri Jan 19, 2018 8:27 pm
You know, the people who have bought into Bitcoin are the same groups of investors (hedge funds, institutions, the general public) who buy the companies in the index fund. It's the exact same pricing/valuation mechanism.

Wouldn't it be more consistent for the Bogleheads who insist that "we don't know more than the market" to then also accept that perhaps Bitcoin is fairly valued?

Or alternatively, to accept that investors can be extremely irrational or emotion-driven, and that the efficient markets theory may not be an accurate description of the investment universe?
When I first started in the investment world, Municipal Bonds were in the "blue book", and there were some morning faxes about Whoops and other low volume bonds:

https://www.investopedia.com/ask/answer ... whoops.asp

Now we have a new technology that is complex and has lots of "fake news" surrounding it, including from people who really have real money invested.

There is no way that you can have an "efficient market" at this early stage. I would also add that you need to update and talk about "Crypto Assets" rather than one asset that was a founder - Bitcoin.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by aristotelian » Fri Jan 19, 2018 8:39 pm

I don't. Efficient markets is a theory that explains a lot but obviously a lot of economic behavior is irrational. If markets were perfectly efficient, there would be no bubbles, no panics, just rational responses to events. It's also clearly being manipulated by insiders who control disproportionate amounts of the currencies. The conditions for the market to be efficient do not exist.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by Caduceus » Fri Jan 19, 2018 8:42 pm

mws13 wrote:
Fri Jan 19, 2018 8:34 pm
Caduceus wrote:
Fri Jan 19, 2018 8:27 pm
You know, the people who have bought into Bitcoin are the same groups of investors (hedge funds, institutions, the general public) who buy the companies in the index fund. It's the exact same pricing/valuation mechanism.

Wouldn't it be more consistent for the Bogleheads who insist that "we don't know more than the market" to then also accept that perhaps Bitcoin is fairly valued?

Or alternatively, to accept that investors can be extremely irrational or emotion-driven, and that the efficient markets theory may not be an accurate description of the investment universe?
When I first started in the investment world, Municipal Bonds were in the "blue book", and there were some morning faxes about Whoops and other low volume bonds:

https://www.investopedia.com/ask/answer ... whoops.asp

Now we have a new technology that is complex and has lots of "fake news" surrounding it, including from people who really have real money invested.

There is no way that you can have an "efficient market" at this early stage. I would also add that you need to update and talk about "Crypto Assets" rather than one asset that was a founder - Bitcoin.

This doesn't sound like a satisfactory answer. If the investors who are buying into Bitcoin can't separate the "fake news" from the real news, why would you be confident in their ability to correctly appraise the value of other assets, including those incorporated in the indexes?

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by ThrustVectoring » Fri Jan 19, 2018 8:44 pm

Cryptocurrency in general is a Keynesian beauty contest where every picture is blank.

Good luck making a speculative buck there. Combined with being less well regulated than penny stocks, I've decided against having any crypto position.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by Taylor Larimore » Fri Jan 19, 2018 8:49 pm

Caduceus wrote:
Fri Jan 19, 2018 8:19 pm
Lots of people on this board seem to believe in a fairly strict version of EMH. How does Bitcoin fit into this view of the investing world?

Is Bitcoin fairly valued by the market at every moment? Has Bitcoin been fairly valued over the last month or year? How do you reconcile these things?
Caduceus:
The efficient market hypothesis (EMH) is an investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. --Investopedia
Caduceus:

I see nothing inconsistent with the price of Bitcoin, the Efficient Market, and the impossibility for most investors (over 50%) to "beat the market."

Best wishes.
Taylor
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by golfCaddy » Fri Jan 19, 2018 9:00 pm

When you say the market is efficient, first you have to define what you mean by the market. Most of the academic research has tested whether the stock market is efficient or whether bond markets are efficient, not whether the market for all assets from OTC derivatives to collectible cars to rare art to crypto-currencies is efficient.
Last edited by golfCaddy on Fri Jan 19, 2018 9:03 pm, edited 1 time in total.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by randomguy » Fri Jan 19, 2018 9:00 pm

aristotelian wrote:
Fri Jan 19, 2018 8:39 pm
I don't. Efficient markets is a theory that explains a lot but obviously a lot of economic behavior is irrational. If markets were perfectly efficient, there would be no bubbles, no panics, just rational responses to events. It's also clearly being manipulated by insiders who control disproportionate amounts of the currencies. The conditions for the market to be efficient do not exist.

I don't think this is correct. A perfectly efficient market will still have bubbles and panics as a result of outside effects. Apple might be priced fairly at todays price. If I wake up tomorrow and learn that a terrorist attack has killed 10k people on the apple campus, my esistimates for their future returns might change. When things change from a probability (60% chance of the drug being approved) to a certainty (drugs was either approved or not) you should expect rapid changes.

Cryptocurrencies are similar bets the winner could easily be worth 100x what it is today. Or it could be worth zero. So the current price reflects that. Or from a traders point of view you are just betting if you can find a bigger sucker:)

And if instead of looking at the market, you just look at stocks, you will see volatility that while not quite on the bitcoin level is pretty large. Gravity Co was up 800% last year. Under Armour was down something like 60%.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by jdilla1107 » Fri Jan 19, 2018 9:03 pm

Efficient doesn't mean correct or rational. Efficient also doesn't mean that "you should own it". The markets for Tuna fish and wood pulp are quite efficient and I would not recommend owning those markets.

Do you have any inside information that will allow you to derive bitcoin profits with no risk? If you have this, I would say that makes bitcoin inefficient. However, if you had this, you would likely move the market so much, you would make it efficient.
Last edited by jdilla1107 on Fri Jan 19, 2018 9:13 pm, edited 1 time in total.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by mws13 » Fri Jan 19, 2018 9:06 pm

Caduceus wrote:
Fri Jan 19, 2018 8:42 pm


This doesn't sound like a satisfactory answer. If the investors who are buying into Bitcoin can't separate the "fake news" from the real news, why would you be confident in their ability to correctly appraise the value of other assets, including those incorporated in the indexes?
I talk to developers, not investors. I have been in Crypto for 5 years, and it was the developers that counseled me to shift to Ethereum. There is a Facebook group for Ethereum investors, and 2 years ago it was an awesome place to get information. Now it is full of kids who want "Lambos" (Lamborghinis, the Italian car), and it is garbage. (Update, just realized it may have only been 1 year ago. Things move quickly.)

If you are reading Coindesk, you are a week/month or two behind the curve. Trust me, I made a bunch of stupid mistakes, but they were small mistakes relative to today. Now I am a boring "Bogle Indexer" with 6 assets/currencies. I had a kid pitch me on his ICO in person today, and it made no sense to me. He did not seem to care as the ICO market is a mess at the current time. He did not care that I said no (nicely) and there were many others to pitch.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by Caduceus » Fri Jan 19, 2018 9:15 pm

mws13 wrote:
Fri Jan 19, 2018 9:06 pm
Caduceus wrote:
Fri Jan 19, 2018 8:42 pm


This doesn't sound like a satisfactory answer. If the investors who are buying into Bitcoin can't separate the "fake news" from the real news, why would you be confident in their ability to correctly appraise the value of other assets, including those incorporated in the indexes?
I talk to developers, not investors. I have been in Crypto for 5 years, and it was the developers that counseled me to shift to Ethereum. There is a Facebook group for Ethereum investors, and 2 years ago it was an awesome place to get information. Now it is full of kids who want "Lambos" (Lamborghinis, the Italian car), and it is garbage.

If you are reading Coindesk, you are a week/month or two behind the curve. Trust me, I made a bunch of stupid mistakes, but they were small mistakes relative to today. Now I am a boring "Bogle Indexer" with 6 currencies. I had a kid pitch me on his ICO in person today, and it made no sense to me. He did not seem to care as the ICO market is a mess at the current time. He did not care that I said no (nicely) and there were many others to pitch.
I think you're misunderstanding the thrust of my posts. I have zero interest in buying Bitcoin or any other such currencies. I am just interested in hearing how folks reconcile their theory of how markets work with the emergence of Bitcoin. I think cryptocurrencies are fundamentally speculative; I just happen to think these bouts of speculation can apply not only to cryptocurrencies but also to stocks. Whereas the argument I am hearing from the posters in this thread is that Tesla is correctly priced based on available information (according to EMH) but Bitcoin isn't. I don't find that convincing at all.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by staythecourse » Fri Jan 19, 2018 9:18 pm

Couple of things...

One isn't bitcoin speculative? That means the price is determined by supply and demand with no inherent value in the asset itself. So no way to make a conclusion on its fair price, i.e. efficient pricing.

Second, hasn't it been shown there are a few folks who own something like 40% of all the bitcoins in which case the pricing is based on their buying and selling impacting the price, i.e. market impact.

Good luck.

p.s. Speculative investments don't subscribe to EMH, but what I call the "hot potato theory" meaning you pass it around and home you aren't the one holding the bag when the music stops.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by Caduceus » Fri Jan 19, 2018 9:22 pm

staythecourse wrote:
Fri Jan 19, 2018 9:18 pm
Couple of things...

One isn't bitcoin speculative? That means the price is determined by supply and demand with no inherent value in the asset itself. So no way to make a conclusion on its fair price, i.e. efficient pricing.

Second, hasn't it been shown there are a few folks who own something like 40% of all the bitcoins in which case the pricing is based on their buying and selling impacting the price, i.e. market impact.

Good luck.

p.s. Speculative investments don't subscribe to EMH, but what I call the "hot potato theory" meaning you pass it around and home you aren't the one holding the bag when the music stops.
How do you define what is speculative? When Tesla wasn't earning anything, was it speculative then? At what point did it cease being a speculative investment (not subject to EMH), and one that was subject to EMH?

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by frugalecon » Fri Jan 19, 2018 9:23 pm

aristotelian wrote:
Fri Jan 19, 2018 8:39 pm
I don't. Efficient markets is a theory that explains a lot but obviously a lot of economic behavior is irrational. If markets were perfectly efficient, there would be no bubbles, no panics, just rational responses to events. It's also clearly being manipulated by insiders who control disproportionate amounts of the currencies. The conditions for the market to be efficient do not exist.
I have thought that this issue of the insiders and their incentives has received insufficient attention. When I see a news story that says that the Winkelvoss twins or Peter Thiel is long on bitcoin and expects it to go way up, why exactly wouldn’t I think that they were or he was trying to pump and dump?
Last edited by frugalecon on Fri Jan 19, 2018 9:25 pm, edited 1 time in total.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by mwm158 » Fri Jan 19, 2018 9:31 pm

.....
Last edited by mwm158 on Sat Jan 20, 2018 3:42 pm, edited 1 time in total.

staythecourse
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by staythecourse » Fri Jan 19, 2018 9:34 pm

Caduceus wrote:
Fri Jan 19, 2018 9:22 pm
staythecourse wrote:
Fri Jan 19, 2018 9:18 pm
Couple of things...

One isn't bitcoin speculative? That means the price is determined by supply and demand with no inherent value in the asset itself. So no way to make a conclusion on its fair price, i.e. efficient pricing.

Second, hasn't it been shown there are a few folks who own something like 40% of all the bitcoins in which case the pricing is based on their buying and selling impacting the price, i.e. market impact.

Good luck.

p.s. Speculative investments don't subscribe to EMH, but what I call the "hot potato theory" meaning you pass it around and home you aren't the one holding the bag when the music stops.
How do you define what is speculative? When Tesla wasn't earning anything, was it speculative then? At what point did it cease being a speculative investment (not subject to EMH), and one that was subject to EMH?
Great question. I would think stocks have an inherent valuations, i.e. capital appreciation+ dividends. Gold, real estate bit coins, tulips, my comic book collection, my baseball card collection, beanie babies, etc... have no inherent value outside of what the current asking price is which is based on supply and demand. Can stocks be OVERvalued or UNDERvalued yes, but they have VALUE in itself. Gold has no value in ITSELF. It does not appreciate and does not throw off dividends, for example.

That is how I read the difference. I'm sure someone can give a better answer then that. You can not EFFICIENTLY price something that has no valuation to PRICE.

Good luck.

p.s. Legos is a great example of speculative. The same legos 20 years ago is worth significantly more now just based on supply/ demand vs. any change in its inherent value.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by McGilicutty » Fri Jan 19, 2018 9:41 pm

Caduceus wrote:
Fri Jan 19, 2018 8:19 pm
Lots of people on this board seem to believe in a fairly strict version of EMH. How does Bitcoin fit into this view of the investing world?

Is Bitcoin fairly valued by the market at every moment? Has Bitcoin been fairly valued over the last month or year? How do you reconcile these things?
Isn't Bogleheads a non-EMH philosophy? A big reason for Bogleheads to own bonds is to cushion the stock-market-bubble pops. Stock market bubbles wouldn't exist in an efficient market, so Bogleheads is de facto a non-EMH philosophy.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by aristotelian » Fri Jan 19, 2018 9:44 pm

randomguy wrote:
Fri Jan 19, 2018 9:00 pm
aristotelian wrote:
Fri Jan 19, 2018 8:39 pm
I don't. Efficient markets is a theory that explains a lot but obviously a lot of economic behavior is irrational. If markets were perfectly efficient, there would be no bubbles, no panics, just rational responses to events. It's also clearly being manipulated by insiders who control disproportionate amounts of the currencies. The conditions for the market to be efficient do not exist.

I don't think this is correct. A perfectly efficient market will still have bubbles and panics as a result of outside effects. Apple might be priced fairly at todays price. If I wake up tomorrow and learn that a terrorist attack has killed 10k people on the apple campus, my esistimates for their future returns might change. When things change from a probability (60% chance of the drug being approved) to a certainty (drugs was either approved or not) you should expect rapid changes.

Cryptocurrencies are similar bets the winner could easily be worth 100x what it is today. Or it could be worth zero. So the current price reflects that. Or from a traders point of view you are just betting if you can find a bigger sucker:)

And if instead of looking at the market, you just look at stocks, you will see volatility that while not quite on the bitcoin level is pretty large. Gravity Co was up 800% last year. Under Armour was down something like 60%.
If efficient market theory just says that there is a market that sets the market price, then yes Bitcoin is arguably efficient. But I would say that turns EM into a tautology and EM is not a useful concept. Even so, I would say Bitcoin provably fails that because of the lack of transparency and oversight, and already documented cases of manipulation.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by MrMillennialMoney » Fri Jan 19, 2018 9:47 pm

The efficient markets theory states that the price of a risky asset (ie bitcoin) reflects all current information.

However, that doesn't mean that information is always correct! Or that information that once was correct will always be correct. New information on bitcoin is coming out every minute. And bitcoin is tradable 24/7, unlike traditional markets which open/close regularly.

Also, just because one believes markets in general are efficient does not mean that all markets are efficient. Or that some markets can't be less efficient than others. That is usually discussed in relation to small-cap stocks or emerging market stocks, but the bitcoin market is by far newer, less transparent, and more dominated by "newbie" investors, which by all measures should make it slightly less efficient than the average market us Bogleheads discuss.

All in all, I do not think that bitcoin's behavior proves the efficient market hypothesis wrong at all.
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by nisiprius » Fri Jan 19, 2018 10:03 pm

I don't think all markets are efficient. Mostly in Bogleheads we are talking about the securities markets, which have been established for over a century, a lot of participation, a lot of liquidity, a lot of regulation involving transparency of important information that affects valuations, specialists who ensure that trading is liquid and orderly, laws against the use of inside information, and relatively little in the way of outright shenanigans. Yes, I think the securities markets are reasonably efficient... and I don't think there's any easy way for me to profit from whatever inefficiencies exist.

But efficient markets don't just happen. Among other things, a high degree of transparency is needed regarding financial events that affect valuation, a degree of transparency that can only result from regulation. In the crypto world, not only are there no such regulations, but I don't think there's even general agreement on what the relevant information affecting valuations would be.

bitcoin and other cryptocurrencies are obviously not efficient markets... or, if you prefer, not really markets at all. There's no way this could happen in an efficient market: (quotes obtained within seconds of each other)

Image

Why aren't arbitrageurs making money out of the spread and forcing the prices together? I'll let the crypto mavens tell me, but I assume that the crypto "market" just costs too much and takes too much time to settle in fiat money.

But, so what? Can people make money out of the inefficient crypto market? I think so, but I don't think I'm one of the people who can. I think it is inconceivable that insider trading, manipulation, and shenanigans are not occurring in the crypto markets. But since I, myself, am not doing these things, the direction of enrichment would be other people making money from me, not me making money from other people.
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by nisiprius » Fri Jan 19, 2018 10:08 pm

P.S. You can debate the validity of the theory, but the dividend discount theory of stock pricing does give a coherent rational intellectual framework for how a stock ought to be valued. It is more of a thought experiment than a procedure because it depends on things like the future interest rates for an indefinitely far distance into the future, but it does answer the question "why should a stock be worth something," and "in theory, if you had information you can't actually have, how would you calculate the number of dollars per share a stock is worth?"

Crypto mavens: what is the crypto equivalent of the dividend discount theory? What pieces of statistical information would you marshall, and, assuming perfect transparency so that you had all the information, what is the calculation you would do in order to determine the number of dollars that a bitcoin should be worth?
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by David Jay » Fri Jan 19, 2018 10:28 pm

Caduceus wrote:
Fri Jan 19, 2018 8:19 pm
Lots of people on this board seem to believe in a fairly strict version of EMH. How does Bitcoin fit into this view of the investing world?

Is Bitcoin fairly valued by the market at every moment? Has Bitcoin been fairly valued over the last month or year? How do you reconcile these things?
EMT says nothing at all about being "fairly" priced or "correctly" priced. It only says that the market price (specifically in the mature stock market) reflects all available public information.

If the market was "accurately" priced, there would never be a flash-crash.
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by golfCaddy » Fri Jan 19, 2018 10:57 pm

nisiprius wrote:
Fri Jan 19, 2018 10:03 pm
bitcoin and other cryptocurrencies are obviously not efficient markets... or, if you prefer, not really markets at all. There's no way this could happen in an efficient market: (quotes obtained within seconds of each other)

Image
The closest situation to this I can think of in equity markets is the disparity between China A-shares and Hong Kong H-shares of the same company.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by columbia » Fri Jan 19, 2018 11:22 pm

No rational person cares about bitcoin.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by KyleAAA » Fri Jan 19, 2018 11:30 pm

The EMH explicitly attempts only to describe deep, liquid public debt and equity markets. No attempt is made by the theory to describe all markets, least of all esoteric markets like cryptocurriences. No reconciliation is necessary as I’m not aware of any version of the theory or any EMH advocate that claims it is universally applicable to all markets. It just isn’t relevant. EMH isn’t a generalize theory of how markets work but rather a theory of how a very small minority of markets with very specific attributes behave. You can easily prove this to your by visiting even a moderately sized farmers market and observe that multiple booths are selling substantially the same product (I.e. an apple) at different prices. And they are ALL selling plenty of them.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by JoMoney » Fri Jan 19, 2018 11:53 pm

I'm not a firm believer in the EMH. It has some holes in it, there are people who make a living out of the holes in it.
I don't believe in the 'rational economic man' theorized in many economic theories. There are many behavioral factors in play with regard to how people participate in a market.

I think there are people who will (and have) made money with Bitcoin, but in aggregate it's a competitive zero-sum game (or worse since new Bitcoins get mined all the time creating inflation). Most of the people who have put money into Bitcoin will get less than what they put in back out. There will be a smaller number of people who come out ahead (taking more money out than they put in). Some of the winners will just be out of luck from there timing, some of the winners will be out of superior skill, information, and superior position to trade in the market (like market makers and exchange operators making a spread and getting commissions). Dumb people get taken advantage of everyday in the market, if the market was "efficient" they would be somewhat protected because theoretically there is no advantage to be had over them, it's all luck or trading rational "risk preferences". It doesn't always work that way.
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by stemikger » Sat Jan 20, 2018 3:11 am

I believe EMH when it comes to 80% of the market.

I believe in CMH when it comes to 100% of the market.

The Cost Matter's Hypothesis is always correct!

For the record, I don't think Jack Bogle is a hardcore EMH follower.

As far as Bitcoin goes, I watched two documentaries on Amazon and a video on You Tube "Entitled Bit Coin for 1st Graders" and I still don't understand it. Needless to say I'll take Jack's advice and avoid Bitcoin like the Plague!
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by FabianMontescu » Sat Jan 20, 2018 4:18 am

Most Economic theories, to be tractable, assume that there's no transaction costs and that there's complete/perfect information in the market. That is the case with EMT. Most versions of EMT will make an exception for inside information precisely because of the information asymmetry that insiders have.

Of course there's information asymmetry in real markets, but in a liquid market with millions of transactions per second, the differences in information between market participants are on average very small. Therefore, even though the assumption of perfect, costless information is absolutely and obviously false for all Finance professors and EMT proponents, it does work fairly well to explain a lot of market behavior.

I think it's useful to think about a parallel with high school Physics. A lot of calculations in high school Physics work fairly well in practice, even though "no friction" is assumed.

In some cases, however, the most important feature is the violation of the basic assumptions of the model. In the case of cryptocurrencies the main feature is incomplete information. A lot of new market participants are coming in without knowing what they're buying. Many market participants in other markets that behave very close to EMT cannot even participate in crypto markets (for a likely example, CalPERS). Many people don't even know how to trade crypto: "Coinbase? ETFs? Do I need to mine?"

It makes sense that the crypto market will be very volatile as information is homogenized between market participants and that it trends upwards over time as more and more participants enter the market. As some particular cryptocurrency starts to look like it has longevity and people understand it more, a lot of money will pour in and price will go up (e.g., Ether from Ethereum).

I think a defining characteristic of a low-information market is that it "falls upwards". You see a lot of news of the market falling but on average it goes up. Even information about a sharp market drop informs a lot of new participants that make the market go back up. I got in early enough not to be overly worried about a bubble. I'd be worried when the shoeshine boy (Joe Kennedy's story about avoiding the 1929 crash) tells me to buy crypto. I think we're not there yet but could soon be.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by Caduceus » Sat Jan 20, 2018 4:28 am

nisiprius wrote:
Fri Jan 19, 2018 10:08 pm
P.S. You can debate the validity of the theory, but the dividend discount theory of stock pricing does give a coherent rational intellectual framework for how a stock ought to be value.

Crypto mavens: what is the crypto equivalent of the dividend discount theory? What pieces of statistical information would you marshall, and, assuming perfect transparency so that you had all the information, what is the calculation you would do in order to determine the number of dollars that a bitcoin should be worth?
I agree with you in your assessment of Bitcoin. It can't be valued using traditional discounting models. But I'm surprised that you don't think your assessment applies equally to a fair number of stocks as well. Many stocks don't have consistent cash flows, so it is impossible to assign future cash flows to them under a discounting model, not even within a reasonable range.

And that's assuming that investors on aggregate are even buying and selling the stock on their own assessment of value based on future cash flows. Would the market still be efficient if the bulk of the trading for a given stock was primarily driven by folks with a speculative intent? In other words, by people who are buying for no other reason than that the stock has recently gone up? Why do the speculative excesses that damn Bitcoin not seem to apply to many stocks in the investment universe too? Because EMH says so?

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by mwm158 » Sat Jan 20, 2018 4:51 am

.....
Last edited by mwm158 on Sat Jan 20, 2018 3:38 pm, edited 1 time in total.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by Lauretta » Sat Jan 20, 2018 5:12 am

bberris wrote:
Fri Jan 19, 2018 8:31 pm

I might make an exception for momentum, which appears to be real, although it might simply be adding risk.
How? Prof. Fama for example thinks that it would be extremely difficult to explain the momentum effect in terms of risk.
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by nisiprius » Sat Jan 20, 2018 5:47 am

Caduceus wrote:
Sat Jan 20, 2018 4:28 am
nisiprius wrote:
Fri Jan 19, 2018 10:08 pm
P.S. You can debate the validity of the theory, but the dividend discount theory of stock pricing does give a coherent rational intellectual framework for how a stock ought to be value.

Crypto mavens: what is the crypto equivalent of the dividend discount theory? What pieces of statistical information would you marshall, and, assuming perfect transparency so that you had all the information, what is the calculation you would do in order to determine the number of dollars that a bitcoin should be worth?
I agree with you in your assessment of Bitcoin. It can't be valued using traditional discounting models. But I'm surprised that you don't think your assessment applies equally to a fair number of stocks as well. Many stocks don't have consistent cash flows, so it is impossible to assign future cash flows to them under a discounting model, not even within a reasonable range.

And that's assuming that investors on aggregate are even buying and selling the stock on their own assessment of value based on future cash flows. Would the market still be efficient if the bulk of the trading for a given stock was primarily driven by folks with a speculative intent? In other words, by people who are buying for no other reason than that the stock has recently gone up? Why do the speculative excesses that damn Bitcoin not seem to apply to many stocks in the investment universe too? Because EMH says so?
Well, you're making me think, but my initial thought is that it is because of cap-weighting. That is, the stocks for which the market is least efficient are also the least important in any kind of cap-weighted average. When you read the index provider's description of how they decide which stocks can be included in a total market index, there is always a lot of complicated legalese dealing with the problem of whether microcap stocks do in fact have any kind of reliable market price. As cap weight decreases, stocks shade off into finally being so dubious that the index provider chooses not to include them.

This is not a new problem. The long-term statistics that go back to 1870 are invariably based on the Cowles Commission's 1939 report, and what the book has to say about what they chose to include is eye-opening. One problem is that about 1/6th of the stocks traded in New York were traded on the "curb exchange," and before about 1922 the prices were so unreliable that the financial newspaper that reported them literally included a warning about them.

This speaks to a discomfort I've always had with the "small" and "small value" tilt ideas, which is that they do indeed keep pushing into riskier and more and more dubious territory. There's alway been a question about how "investible" various factors are. Rick Ferri had an article on how unsatisfactory microcap index funds and ETFs are--there was a finally a year when microcaps really shone, with like maybe a +45% index gain, and the index funds and ETFs that were supposedly tracking the index only managed to capture half of the index gains. DFA's funds have done better but at the expense of not tracking an index and IMHO not really being passive.

It's a little reminiscent of the argument sometimes made about Wikipedia, which depends on "many eyes" to keep articles accurate and correct mistakes. The claim is that articles that few people read may be inaccurate, but it's relatively unimportant because they are unimportant articles; article that many people read get many eyes viewing them, mistakes are much more likely to be corrected, and thus the most important articles have the highest level of accuracy.
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by JCE66 » Sat Jan 20, 2018 7:00 am

Caduceus....IMHO, what we see with Bitcoin is the very essence of EMH. The 'crypto-currency market' is brutally efficient, it seems to me.

I 'sort of' have a handle on what Bitcoin is, and what it represents. And I am grappling with blockchain. Larry Swedroe wrote an article on cryptocurrency and blockchain in December 2017 that I found informative and helpful. That said, I am eyeing a few things in the 'digital realm', asking questions, reading about it, gaining an understanding of the concepts, and the business model. For now, I am keeping my distance and watching. I just do not know enough about it to jump in. Perhaps in time.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by bgf » Sat Jan 20, 2018 8:00 am

EMH is like high school physics; it provides a solution to a problem but only by assuming interactions happen in a vacuum without friction...

if anything crypto is proof against EMH. the volatility inherent over time shows that buyers and sellers are not acting in concert to assimilate all information and reach a stable price.

people on this thread talk about how 'new information' comes along all the time. but that simply isn't true. no real new fundamental information on bitcoin comes along every hour, yet its price changes drastically from hour to hour, day after day.

what does change from hour to hour is its price. buyers and sellers use the price of bitcoin itself as new information in determining their transactions. this creates feedback loops which lead to extreme price swings. buyers and sellers adapt to the extreme price swings and take them into account in future transactions... The extreme uncertainty around bitcoin is fascinating because it allows us to observe market behavior with little if any fundamental anchor. in other words, you can see the sheer power of feedback loops.
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by goblue100 » Sat Jan 20, 2018 8:12 am

I think Ben Graham said it best.
In the short run, the market is like a voting machine. But in the long run, the market is like a weighing machine.
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by Valuethinker » Sat Jan 20, 2018 9:38 am

FabianMontescu wrote:
Sat Jan 20, 2018 4:18 am
Most Economic theories, to be tractable, assume that there's no transaction costs and that there's complete/perfect information in the market. That is the case with EMT. Most versions of EMT will make an exception for inside information precisely because of the information asymmetry that insiders have.

Of course there's information asymmetry in real markets, but in a liquid market with millions of transactions per second, the differences in information between market participants are on average very small. Therefore, even though the assumption of perfect, costless information is absolutely and obviously false for all Finance professors and EMT proponents, it does work fairly well to explain a lot of market behavior.

I think it's useful to think about a parallel with high school Physics. A lot of calculations in high school Physics work fairly well in practice, even though "no friction" is assumed.

In some cases, however, the most important feature is the violation of the basic assumptions of the model. In the case of cryptocurrencies the main feature is incomplete information. A lot of new market participants are coming in without knowing what they're buying. Many market participants in other markets that behave very close to EMT cannot even participate in crypto markets (for a likely example, CalPERS). Many people don't even know how to trade crypto: "Coinbase? ETFs? Do I need to mine?"

It makes sense that the crypto market will be very volatile as information is homogenized between market participants and that it trends upwards over time as more and more participants enter the market. As some particular cryptocurrency starts to look like it has longevity and people understand it more, a lot of money will pour in and price will go up (e.g., Ether from Ethereum).

I think a defining characteristic of a low-information market is that it "falls upwards". You see a lot of news of the market falling but on average it goes up. Even information about a sharp market drop informs a lot of new participants that make the market go back up. I got in early enough not to be overly worried about a bubble. I'd be worried when the shoeshine boy (Joe Kennedy's story about avoiding the 1929 crash) tells me to buy crypto. I think we're not there yet but could soon be.

Was it a shoeshine boy?

I understood that it was Bernard Baruch and an elevator operator?

Do you have a citation?

Baruch, in fact, did not sell (wholly) and took heavy losses in the crash.

BTW on cryptocurrencies we are all well past the modern equivalent of an elevator operator. All sorts of people have the ap on their phones and are busy trading.

This will not end well.


http://www.thehindubusinessline.com/200 ... 0818s1.htm

suggests it was Henry Ford NOT Bernard Baruch.

http://articles.baltimoresun.com/1996-0 ... th-reading

quotes Baruch
LOOKING BACK: Bernard Baruch, highly successful investor, said, in 1929, just before the Big Crash, "When every taxi driver, shoeshine boy and elevator operator tells me how much money they're making in the stock market, I get out."

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by rustymutt » Sat Jan 20, 2018 10:03 am

I just avoid fads like Bitcoin. I'd rather go to the casino for my thrills. And I don't even do that anymore. Why I even stopped betting the greyhounds at the dog track. If you like losing your lunch, then go for it. That's my take on Bitcoin.

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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by nisiprius » Sat Jan 20, 2018 10:23 am

Oh, one detail. There is no "efficient markets theory." There is an efficient markets hypothesis, EMH.

An hypothesis is a possibility that is tested by observation and experiment. It's a term taken from science, but because it is impossible to perform experiments in financial economics, it is not possible to apply the scientific method. The "efficient markets hypothesis" was developed by Eugene Fama--I think he coined the phrase. The efficient markets hypothesis makes predictions that are definite enough that you could conceivably find observations that would contradict the predictions and "falsify" the hypothesis. I think some of the predictions are that if markets are efficient, then 1) prices will follow a random walk, and that 2) technical analysis cannot work--you cannot beat the market by observing past price movements alone.

There isn't any point at which an hypothesis officially becomes a theory, but it takes a long time, a lot of failure-to-disprove, and a lot of social consensus among working scientists. Not only has the EMH not reached that point, but if the Fama-French three-factor model is correct, then the three-factor model itself actually disproves the EMH.

My personal way of looking at it is to analogize it with the three "laws" of thermodynamics, particularly the first. One way of phrasing the first law of thermodynamics is to say "perpetual motion machines" (i.e. machines that produce more energy than they consume) are impossible. Historically the laws of thermodynamics came out of a lot of very serious effort to build perpetual motion machines. The effort continues to this day, under the name "overunity," and a YouTube search on "overunity" will find you many videos of alleged overunity engines in action--some big, noisy, and powerful-looking.

Thus, just as there are (many) people who do not believe the EMH, there are (a surprising number) of people who do not believe the first law of thermodynamics. Some of them are just hobbyists, others are apparently hoping to sell you things--the "overunity" community probably contains both honest people and swindlers.

The EMH has more than one form, ranging from the simple "you can't beat the market by using only past price information" to the full-bore Chicago-school "the market sees all, knows all, past, present, and future, world without end, amen." To me, what the EMH says is that "it is surprisingly difficult to beat the market," and a century or so of minds of every caliber, working very hard at the problem, motivated directly by money, have failed to falsify this statement.
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by Lauretta » Sat Jan 20, 2018 11:48 am

nisiprius wrote:
Sat Jan 20, 2018 10:23 am
Oh, one detail. There is no "efficient markets theory." There is an efficient markets hypothesis, EMH.

An hypothesis is a possibility that is tested by observation and experiment. It's a term taken from science, but because it is impossible to perform experiments in financial economics, it is not possible to apply the scientific method. The "efficient markets hypothesis" was developed by Eugene Fama--I think he coined the phrase. The efficient markets hypothesis makes predictions that are definite enough that you could conceivably find observations that would contradict the predictions and "falsify" the hypothesis. I think some of the predictions are that if markets are efficient, then 1) prices will follow a random walk, and that 2) technical analysis cannot work--you cannot beat the market by observing past price movements alone.

There isn't any point at which an hypothesis officially becomes a theory, but it takes a long time, a lot of failure-to-disprove, and a lot of social consensus among working scientists. Not only has the EMH not reached that point, but if the Fama-French three-factor model is correct, then the three-factor model itself actually disproves the EMH.

My personal way of looking at it is to analogize it with the three "laws" of thermodynamics, particularly the first. One way of phrasing the first law of thermodynamics is to say "perpetual motion machines" (i.e. machines that produce more energy than they consume) are impossible. Historically the laws of thermodynamics came out of a lot of very serious effort to build perpetual motion machines. The effort continues to this day, under the name "overunity," and a YouTube search on "overunity" will find you many videos of alleged overunity engines in action--some big, noisy, and powerful-looking.

Thus, just as there are (many) people who do not believe the EMH, there are (a surprising number) of people who do not believe the first law of thermodynamics. Some of them are just hobbyists, others are apparently hoping to sell you things--the "overunity" community probably contains both honest people and swindlers.

The EMH has more than one form, ranging from the simple "you can't beat the market by using only past price information" to the full-bore Chicago-school "the market sees all, knows all, past, present, and future, world without end, amen." To me, what the EMH says is that "it is surprisingly difficult to beat the market," and a century or so of minds of every caliber, working very hard at the problem, motivated directly by money, have failed to falsify this statement.
I am not sure that the comparison with physics really make sense. The law of conservation of energy can be tested in innumerable experiments and has never so far been falsified.
My understanding at present (but I am not 100% sure as I have not yet learnt enough about it) is that the EMH cannot be unambiguously falsified, because of the joint hypothesis problem (i.e. anomalous market returns may reflect market inefficiency, but they could instead be due to an inaccurate asset pricing model, or to both)
https://en.wikipedia.org/wiki/Joint_hypothesis_problem
If it's not falsifiable, the EMH cannot be considered a scientific theory using Karl Popper's widely accepted criterion.
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by arcticpineapplecorp. » Sat Jan 20, 2018 12:00 pm

nisiprius wrote:
Sat Jan 20, 2018 10:23 am
Oh, one detail. There is no "efficient markets theory." There is an efficient markets hypothesis, EMH.

An hypothesis is a possibility that is tested by observation and experiment. It's a term taken from science, but because it is impossible to perform experiments in financial economics, it is not possible to apply the scientific method. The "efficient markets hypothesis" was developed by Eugene Fama--I think he coined the phrase. The efficient markets hypothesis makes predictions that are definite enough that you could conceivably find observations that would contradict the predictions and "falsify" the hypothesis. I think some of the predictions are that if markets are efficient, then 1) prices will follow a random walk, and that 2) technical analysis cannot work--you cannot beat the market by observing past price movements alone.

There isn't any point at which an hypothesis officially becomes a theory, but it takes a long time, a lot of failure-to-disprove, and a lot of social consensus among working scientists. Not only has the EMH not reached that point, but if the Fama-French three-factor model is correct, then the three-factor model itself actually disproves the EMH.

My personal way of looking at it is to analogize it with the three "laws" of thermodynamics, particularly the first. One way of phrasing the first law of thermodynamics is to say "perpetual motion machines" (i.e. machines that produce more energy than they consume) are impossible. Historically the laws of thermodynamics came out of a lot of very serious effort to build perpetual motion machines. The effort continues to this day, under the name "overunity," and a YouTube search on "overunity" will find you many videos of alleged overunity engines in action--some big, noisy, and powerful-looking.

Thus, just as there are (many) people who do not believe the EMH, there are (a surprising number) of people who do not believe the first law of thermodynamics. Some of them are just hobbyists, others are apparently hoping to sell you things--the "overunity" community probably contains both honest people and swindlers.

The EMH has more than one form, ranging from the simple "you can't beat the market by using only past price information" to the full-bore Chicago-school "the market sees all, knows all, past, present, and future, world without end, amen." To me, what the EMH says is that "it is surprisingly difficult to beat the market," and a century or so of minds of every caliber, working very hard at the problem, motivated directly by money, have failed to falsify this statement.
Thanks for pointing that out. Kinda like people who say evolution is "only" a theory. They don't understand what the definition of a theory is.

By that measure EMH should remain a hypothesis not a theory, but shouldn't it then be the Costs Matter Theory, rather than the Costs Matter Hypothesis?
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by willthrill81 » Sat Jan 20, 2018 12:07 pm

aristotelian wrote:
Fri Jan 19, 2018 8:39 pm
I don't. Efficient markets is a theory that explains a lot but obviously a lot of economic behavior is irrational. If markets were perfectly efficient, there would be no bubbles, no panics, just rational responses to events. It's also clearly being manipulated by insiders who control disproportionate amounts of the currencies. The conditions for the market to be efficient do not exist.
+1

Behavioral finance has, in the minds of many finance experts, shown the EMH to not be strictly true.
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by IlliniDave » Sat Jan 20, 2018 12:07 pm

To me EMH means that a market accurately reflects the aggregate opinion of the participants regarding pricing on an ongoing basis. Since the pricing is derived by humans (and often reflecting their predictions for the future) based on what is known at the time, it is prone to being shown wrong in hindsight. That isn't exactly Fama's EMH, just my way of thinking about it. What is actionable for me is that when I come across a bit of information that might tempt me to have an opinion about the future value of a stock, it's best to assume the value of that bit of information is already reflected in the price, and that I should leave speculation on individual stocks to people with money to burn.

My own logical inconsistency is that I do look at market-wide valuations and have no problem backing off a little when they look high (like they are now) or wading in a step or two deeper when they look low (like in 2008).
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Re: How do Bogleheads reconcile efficient markets theory with Bitcoin?

Post by willthrill81 » Sat Jan 20, 2018 12:10 pm

randomguy wrote:
Fri Jan 19, 2018 9:00 pm
I don't think this is correct. A perfectly efficient market will still have bubbles and panics as a result of outside effects.
A strict interpretation of the EMH requires rational actors. If those actors cease behaving rationally, as in the case of market turbulence, all bets are off.
Investors, including the likes of Warren Buffett, and researchers have disputed the efficient-market hypothesis both empirically and theoretically. Behavioral economists attribute the imperfections in financial markets to a combination of cognitive biases such as overconfidence, overreaction, representative bias, information bias, and various other predictable human errors in reasoning and information processing. These have been researched by psychologists such as Daniel Kahneman, Amos Tversky, Richard Thaler, and Paul Slovic. These errors in reasoning lead most investors to avoid value stocks and buy growth stocks at expensive prices, which allow those who reason correctly to profit from bargains in neglected value stocks and the overreacted selling of growth stocks. Investors prefer riskier funds in spring and safer funds in autumn.
https://en.wikipedia.org/wiki/Efficient ... hypothesis

The EMH assumes that all of the biases among the actors in a market cancel each other out. However, behavioral finance has demonstrated that a majority of actors in a market can suffer from the same biases, so it is impossible for these biases to balance out.

Further, many believe that the EMH implies the random walk hypothesis, which is believed by many to be false.
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