Is EMH a tautology?

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AlphaLess
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Re: Is EMH a tautology?

Post by AlphaLess » Sat Oct 13, 2018 9:56 pm

vineviz wrote:
Sat Oct 13, 2018 9:33 pm
If you're going to try to take down the theory, you'd probably better start with the primary research and not the encyclopedia version.

There is over a century's worth of literature on the topic (and the 1970 paper by Fama, for which he won the nobel prize, is THE most cited paper in financial economics): I think if you dig into it you'll find many of your questions answered and misconceptions dispelled.
Thank you for bringing focus to the discussion.

Consider this, for example:

https://www.bloomberg.com/view/articles ... some-fraud

How do you treat the information in that case?

Is it private?
Is it available?
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TomCat96
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Re: Is EMH a tautology?

Post by TomCat96 » Sat Oct 13, 2018 10:07 pm

Lauretta wrote:
Sat Oct 13, 2018 4:39 am
In a discussion yesterday where I was trying to articulate my thoughts on EMH, I wrote that since EMH cannot be tested because it has no predictive power (due to the joint hypothesis problem - meaning that you will never kown whether it's EMH that is false, or the asset pricing model used that is false), it has no scientific value as a hypothesis: as Karl Popper noted, scientific statements must be falsifiable to be meaningful.

viewtopic.php?f=10&t=261191&p=4163099#p4162277

Since the response of several posters was that I did not understand EMH, I researched it a bit further and came across this post, saying the same thing:

https://obliviousinvestor.com/testing-e ... s-problem/

In other words, one will never be able to prove that EMH is wrong, because it is always possible to 'blame' the asset pricing model, and say that it's the latter that needs improving.

The author of the post is regularly invited to speak at Bogleheads meetings, so perhaps his opinion will give more authority to this statement.
To be sure his piece concludes that since EMH cannot be falsified, one should be wearly of those who say they proved it's wrong.

But my claim is that precisely because it cannot be tested and thus is not falisfiable, it has absolutely no scientific value. It is just a tautology and I am more and more puzzled why people (besides academics) take it seriously.

In fact even Fama thinks that the momentum effect makes EMH very dubious, since one would need a particular crazy asset pricing model to justify the quickly shifting risk in momentum stocks. I saw a video in which Fama joked that he hopes that the momentum effect goes away, so that EMH will become more believable (or less incredible). Perhaps this gives an indication of how EMH should be taken, light heartedly and more as a joke, rather than with the seriousness and dogmatic attitude that many (who aren't equipped to think of the grounds on which it is built) have?
EMH as I've said is one of the most misunderstood concepts on this website. But I think you are right. The way that EMH is often understood is "near tautological". It's hard to conceive of a situation where it would not be true, except of course the situation where a market is so inefficient that the masses are capable of making money from inefficiencies they see.

I don't entertain efficient market theory at all, at least not in any academic well understood form. At such a high level of generality it becomes a useless and meaningless philosophy. It is knowledge that does no work, provides no benefit. Tautologies are useless. They are ambiguously self-proving, allowing no cogent set of deductions to made from them.

The point at which the idea of an efficient market can work for you as a constructive piece of knowledge is to ask "how efficient is the efficient market?"

Consider the Stock market vs your local real estate market, the collectibles market, the market for books, the market for antique typewriters, the market for used cereal boxes. Each of these markets operate at a different level of efficiency. Each of them has a different set of barriers to entry. Each of these have major players and actors. Each of them has a daily volume, a finite number of transactions which occur daily.

I think the most misunderstood point about the stock market is that it is efficient, thereby abnormal profits cannot be made forever. First and foremost, in a strict sense that cannot be true. And those who follow other markets understand why. It's not that the stock market is efficient, it's that it is much more efficient than your local used cereal box market. There is no point where a market gets to be deemed "efficient." It's just an arbitrary point based on emotions, gut checks, perspectives, etc.

Is my local used cereal box market efficient? Let's say the reasonable answer is no. Well why not? There's so few people participating in something so odd, that if I make profit in it, it's cause there weren't enough eyes watching the closing seconds on that vintage 1979 box of cheerios on ebay.

Does that make it "inefficient?" Again the demarcation of inefficient is nothing but an arbitrary point.

If one gets used to the idea that all markets are really on a spectrum of inefficiency and efficiency, you can get some work done. You can say to yourself, I know my efforts are likely wasted in trying to predict the market. It's too efficient of a market for me to make proper headway. My stray thoughts about a hot stock tip I'm getting from a neighbor probably aren't enough to counter the legions of analysts doing this for a living.

On the other hand, it allows you to raise the question to yourself, "what markets are inefficient enough that with my level of insight, I can make abnormal profits?" That's where the idea of an efficient or inefficient market can start to help you out, do real work for you.
That's the right question to ask.

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Re: Is EMH a tautology?

Post by gmaynardkrebs » Sun Oct 14, 2018 8:25 am

EMH is better described as reductionist rather than tautological. Information" is not a basic state in the way atoms or perhaps a quark are in physics. For example, that he market price of X reflects the "tastes" of all market participants, but what is a "taste" in the market context? "Tastes" include by all sorts of non-objective, social and psychological phenomena, such as "exuberance," beliefs about the future, manias, CNBC, chartists, etc etc.

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Re: Is EMH a tautology?

Post by vineviz » Sun Oct 14, 2018 8:43 am

TomCat96 wrote:
Sat Oct 13, 2018 10:07 pm
EMH as I've said is one of the most misunderstood concepts on this website. But I think you are right. The way that EMH is often understood is "near tautological". It's hard to conceive of a situation where it would not be true, except of course the situation where a market is so inefficient that the masses are capable of making money from inefficiencies they see.
This is much easier to say now than it was before the research on market efficiency was actually done. It wasn't very long ago that conventional wisdom posited that technical and/or fundamental analysis could be used to generate above-average returns for sufficiently skilled investors. The fact that people PERCEIVE the EMH to be self-evident is actually due to strength of the empirical research used to bring the EMH into our lexicon.
TomCat96 wrote:
Sat Oct 13, 2018 10:07 pm
Ithink the most misunderstood point about the stock market is that it is efficient, thereby abnormal profits cannot be made forever. First and foremost, in a strict sense that cannot be true.
This is really nothing more than a caricature of the EMH, though.The EMH makes some specific and well-formed predictions about asset returns, and not one of them is "abnormal profits cannot be made forever".

The following quote doesn't go into the full detail, but it should provide some (I hope) useful perspective. It's the first two paragraphs from Fama's 1991 review paper on the then-current state of research:

I take the market efficiency hypothesis to be the simple statement that security prices fully reflect all available information. A precondition for this strong version of the hypothesis is that information and trading costs, the costs of getting prices to reflect information, are always 0 (Grossman and Stiglitz (1980)). A weaker and economically more sensible version of the efficiency hypothesis says that prices reflect information to the point where the marginal benefits of acting on information (the profits to be made) do not exceed the marginal costs (Jensen (1978)).

Since there are surely positive information and trading costs, the extreme version of the market efficiency hypothesis is surely false. Its advantage, however, is that it is a clean benchmark that allows me to sidestep the messy problem of deciding what are reasonable information and trading costs. I can focus instead on the more interesting task of laying out the evidence on the adjustment of prices to various kinds of information. Each reader is then free to judge the scenarios where market efficiency is a good approximation (that is, deviations from the extreme version of the efficiency hypothesis are within information and trading costs) and those where some other model is a better simplifying view of the world.
Many Bogleheads will read the first sentence of the second paragraph and think they've learned all they need to know about EMH, but that would be a grave error.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Ron Scott
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Re: Is EMH a tautology?

Post by Ron Scott » Sun Oct 14, 2018 9:03 am

EMH epitomizes the dearth in value from economic theorizing, economists talking with economists about suspect propositions unnecessary in the real world.

EMH proposes to know that the success of any strategy that varies from the standard will always fail. And temporary success is by definition discounted. Therefore the proposition cannot be tested in real time.

Furthermore, the proof of EHM (success of TSM over alternatives) does not require EMH to explain it. So the value of EMH is undefined.

We give EMH its power simply by considering it and the pro-con arguments we advance appear to form the circular reasoning you're concerned with,
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Re: Is EMH a tautology?

Post by JoMoney » Sun Oct 14, 2018 12:19 pm

Ron Scott wrote:
Sun Oct 14, 2018 9:03 am
...the proof of EHM (success of TSM over alternatives) does not require EMH to explain it. So the value of EMH is undefined...
I think that's the other way around. EMH doesn't really have a proof, and the "proof" or success of broad market investing doesn't rely on EMH.
It's simple arithmetic to prove that the aggregate of investors can't achieve higher returns than the sum total of the market, and that the aggregate risk of the market as a system is represented by the aggregate of the stocks as well.
EMH takes that 'proof' and further suggests that you can't subdivide the market to increase returns without also increasing risk, which seems like a reasonable proposition, but when various static measurements/models for risk are attempted, they seem to run into "anomalies" that run counter to what the model would suggest. Even in the bond market, it can be found that the highest credit bonds have lower returns than higher risk bonds, which is what the hypothesis would suggest, but the relationship to risk isn't as linear as some models would suggest, the lowest rated bonds empirically don't have higher returns.
It would be valuable to have a complete and working model/measurement of risk, certainly performance chasers like the idea of a model that would explain how to get higher returns, but the premise that there is some static linear relationship that can be measured between risk/return doesn't seem to work out in practice, and while there aren't more individuals beating the market then chance alone would explain, the fact that some of the same individuals remain in that group for long periods of time, some of them from the same school of thought (i.e. Graham and Doddesville) is an extreme event that chance would not explain.
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Re: Is EMH a tautology?

Post by Ron Scott » Sun Oct 14, 2018 12:58 pm

JoMoney wrote:
Sun Oct 14, 2018 12:19 pm
Ron Scott wrote:
Sun Oct 14, 2018 9:03 am
...the proof of EHM (success of TSM over alternatives) does not require EMH to explain it. So the value of EMH is undefined...
I think that's the other way around. EMH doesn't really have a proof, and the "proof" or success of broad market investing doesn't rely on EMH.
It's simple arithmetic to prove that the aggregate of investors can't achieve higher returns than the sum total of the market, and that the aggregate risk of the market as a system is represented by the aggregate of the stocks as well.
EMH takes that 'proof' and further suggests that you can't subdivide the market to increase returns without also increasing risk, which seems like a reasonable proposition, but when various static measurements/models for risk are attempted, they seem to run into "anomalies" that run counter to what the model would suggest. Even in the bond market, it can be found that the highest credit bonds have lower returns than higher risk bonds, which is what the hypothesis would suggest, but the relationship to risk isn't as linear as some models would suggest, the lowest rated bonds empirically don't have higher returns.
It would be valuable to have a complete and working model/measurement of risk, certainly performance chasers like the idea of a model that would explain how to get higher returns, but the premise that there is some static linear relationship that can be measured between risk/return doesn't seem to work out in practice, and while there aren't more individuals beating the market then chance alone would explain, the fact that some of the same individuals remain in that group for long periods of time, some of them from the same school of thought (i.e. Graham and Doddesville) is an extreme event that chance would not explain.
A friend of mine recently asked me what I thought of Robert Plant's latest outing (2017's "Carry Fire") and I told him I assess new albums from old pros by asking myself if the new album could launch the career of an unknown.

When assessing theories like EMH I ask myself 2 questions before worrying about its veracity: a) Is there a useful application in the real world for this theory that would not be readily apparent but for the theory?, and b) Is the theory from original theoretical thinking that can kickstart some new applications, or is it an attempt to codify existing real world practices into a set of heuristics or some such.

To my mind EMH fails both tests. The theory is totally unnecessary to achieve the gains it hopes to advance, and people were practicing diversification well before even the earliest versions of EMH. So when confronted with EMH I'm just left wondering the same thing I wonder when reading the vast majority of economists: Why? (Yes, I am tough on theorists and economists. I know much of what is published is b...t and I have a penchant for the practical.)

Plant BTW would pass the test IMO: An outstanding work.
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Re: Is EMH a tautology?

Post by vineviz » Sun Oct 14, 2018 1:11 pm

Ron Scott wrote:
Sun Oct 14, 2018 12:58 pm
The theory is totally unnecessary to achieve the gains it hopes to advance, and people were practicing diversification well before even the earliest versions of EMH.
I think you could only say such a thing with a straight face if you knew nothing about both what the theory actually says and the history of its development.

Fama published his paper on EMH in 1970, the paper that is the most cited paper in fiannce to this day AND the paper that arguably won him the Nobel Prize. Question: before 197, when this paper was published, how many passively managed mutual funds were available to retail investors?
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Is EMH a tautology?

Post by stlutz » Sun Oct 14, 2018 1:12 pm

triceratop wrote:
Sat Oct 13, 2018 5:47 pm
There is a good discussion between Thaler and Fama with Andrew Lo on Youtube, here.
Thanks for sharing the video--I enjoyed listening to it!

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Re: Is EMH a tautology?

Post by stlutz » Sun Oct 14, 2018 1:51 pm

I think what has made EMH both useful and problematic is it's dependence on an agreed-upon understanding of how to measure risk, which there isn't one. That has made EMH a rather elastic concept.

Value stocks are a case in point. Some would argue that if one type of stock consistently produces a higher Sharpe Ratio than the market as a whole, this is evidence of chronic inefficiency. Others say that if we define the meaning of risk, or if we just make risk completely undefinable, then the outperformance of value stocks if great evidence that markets are efficient.

If value stocks fail to outperform over a 25 year period (i.e. the last 25) one group may say this is efficiency in action--a mispricing was identified and the market fixed it. Others say this is just evidence of the risk of value stocks--which will lead to outperformance in the future.

This type of broad-based, long-term anomaly/observation should be the type of thing that can be used to support or reject the hypothesis, but it has done neither.

Eric Falkenstein in The Missing Risk Premium argues that lower risk investments produce higher returns--definitely on a Sharpe Ratio basis and sometimes on an absolute basis. Yet in the end he claims to be an EMH/Fama fan--he just argues that risk needs to be defined differently. It is relative, not absolute. Risk is not $100 becoming $50; rather it's not doing as well as my neighbor. With that understanding of risk, the pattern he observes becomes consistent with the hypothesis as well.

In the field of the investing, the biggest problem I see with EMH is that it has been turned into too useful of a marketing concept. Those selling value strategies can use it to claim it's some type of firm economic law that their favored stocks should outperform. But it also gets used to explain why risk parity strategies are the way to go. As noted, it's even used to promote low volatility strategies.

That all quite ironic as much of the original idea behind EMH is that it is very difficult to predict what will be a good strategy as returns are dependent on future events--current prices already reflect past and current knowledge.

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Re: Is EMH a tautology?

Post by Ron Scott » Sun Oct 14, 2018 2:02 pm

vineviz wrote:
Sun Oct 14, 2018 1:11 pm
Ron Scott wrote:
Sun Oct 14, 2018 12:58 pm
The theory is totally unnecessary to achieve the gains it hopes to advance, and people were practicing diversification well before even the earliest versions of EMH.
I think you could only say such a thing with a straight face if you knew nothing about both what the theory actually says and the history of its development.

Fama published his paper on EMH in 1970, the paper that is the most cited paper in fiannce to this day AND the paper that arguably won him the Nobel Prize. Question: before 197, when this paper was published, how many passively managed mutual funds were available to retail investors?
You need to read what people wrote before you shoot. I spole of diversification, not active vs. passive funds. I know when the passive party started.
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Re: Is EMH a tautology?

Post by vineviz » Sun Oct 14, 2018 2:12 pm

Ron Scott wrote:
Sun Oct 14, 2018 2:02 pm
You need to read what people wrote before you shoot. I spole of diversification, not active vs. passive funds. I know when the passive party started.
I guess you confused me because diversification has nothing at all to do with EMH.
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Re: Is EMH a tautology?

Post by triceratop » Sun Oct 14, 2018 2:12 pm

stlutz wrote:
Sun Oct 14, 2018 1:12 pm
triceratop wrote:
Sat Oct 13, 2018 5:47 pm
There is a good discussion between Thaler and Fama with Andrew Lo on Youtube, here.
Thanks for sharing the video--I enjoyed listening to it!
Thank you for saying so! I find it more informative of what these academics think than many comments which purport to describe their beliefs, which coincidentally align with those people's actual beliefs. It's convenient when my understanding is that Nobel winners agree with me :)
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Re: Is EMH a tautology?

Post by Ron Scott » Sun Oct 14, 2018 2:19 pm

vineviz wrote:
Sun Oct 14, 2018 2:12 pm
Ron Scott wrote:
Sun Oct 14, 2018 2:02 pm
You need to read what people wrote before you shoot. I spoke of diversification, not active vs. passive funds. I know when the passive party started.
I guess you confused me because diversification has nothing at all to do with EMH.
The primary implication of the EMH that people focus on is that it is impossible to beat the market on a consistent basis. People were diversifying before the advent of these funds and EMH theory to gain enough exposure to the broader market so they could rise with it and avoid going down with too concentrated an exposure.
Retirement is a game best played by those prepared for more volatility in the future than has been seen in the past. The solution is not to predict investment losses but to prepare for them.

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Re: Is EMH a tautology?

Post by vineviz » Sun Oct 14, 2018 2:21 pm

Ron Scott wrote:
Sun Oct 14, 2018 2:19 pm
vineviz wrote:
Sun Oct 14, 2018 2:12 pm
Ron Scott wrote:
Sun Oct 14, 2018 2:02 pm
You need to read what people wrote before you shoot. I spoke of diversification, not active vs. passive funds. I know when the passive party started.
I guess you confused me because diversification has nothing at all to do with EMH.
The primary implication of the EMH that people focus on is that it is impossible to beat the market on a consistent basis. People were diversifying before the advent of these funds and EMH theory to gain enough exposure to the broader market and rise with it.
Again, your first sentence (even if it were a reasonable summation of EMH) has nothing to do with your second sentence: EMH has nothing to say about diversification. At all.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Is EMH a tautology?

Post by Ron Scott » Sun Oct 14, 2018 2:36 pm

vineviz wrote:
Sun Oct 14, 2018 2:21 pm
Ron Scott wrote:
Sun Oct 14, 2018 2:19 pm
vineviz wrote:
Sun Oct 14, 2018 2:12 pm
Ron Scott wrote:
Sun Oct 14, 2018 2:02 pm
You need to read what people wrote before you shoot. I spoke of diversification, not active vs. passive funds. I know when the passive party started.
I guess you confused me because diversification has nothing at all to do with EMH.
The primary implication of the EMH that people focus on is that it is impossible to beat the market on a consistent basis. People were diversifying before the advent of these funds and EMH theory to gain enough exposure to the broader market and rise with it.
Again, your first sentence (even if it were a reasonable summation of EMH) has nothing to do with your second sentence: EMH has nothing to say about diversification. At all.
Uh boy... A major implication of the theory is that a diversified low-fee portfolio--with no "information cost"--will beat stock picking. Hence, the chance of picking an undervalued stock is essentially random...and keeping trading to a minimum would be the way to go.

I'm done.
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Re: Is EMH a tautology?

Post by triceratop » Sun Oct 14, 2018 2:39 pm

Ron Scott wrote:
Sun Oct 14, 2018 2:36 pm
vineviz wrote:
Sun Oct 14, 2018 2:21 pm
Ron Scott wrote:
Sun Oct 14, 2018 2:19 pm
The primary implication of the EMH that people focus on is that it is impossible to beat the market on a consistent basis. People were diversifying before the advent of these funds and EMH theory to gain enough exposure to the broader market and rise with it.
Again, your first sentence (even if it were a reasonable summation of EMH) has nothing to do with your second sentence: EMH has nothing to say about diversification. At all.
Uh boy... A major implication of the theory is that a diversified low-fee portfolio--with no "information cost"--will beat stock picking. Hence, the chance of picking an undervalued stock is essentially random...and keeping trading to a minimum would be the way to go.

I'm done.
Implications and corollaries of a hypothesis or theory should not be confused with the actual statement of the hypothesis or theory.
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Re: Is EMH a tautology?

Post by vineviz » Sun Oct 14, 2018 2:39 pm

Ron Scott wrote:
Sun Oct 14, 2018 2:36 pm
Uh boy... A major implication of the theory is that a diversified low-fee portfolio--with no "information cost"--will beat stock picking. Hence, the chance of picking an undervalued stock is essentially random...and keeping trading to a minimum would be the way to go.
You're still not getting it: the efficient market hypothesis has no implications related to diversification at all.

There are OTHER important theories that have a lot to say about diversification, but EMH isn't one of them.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Is EMH a tautology?

Post by Ron Scott » Sun Oct 14, 2018 3:08 pm

vineviz wrote:
Sun Oct 14, 2018 2:39 pm
Ron Scott wrote:
Sun Oct 14, 2018 2:36 pm
Uh boy... A major implication of the theory is that a diversified low-fee portfolio--with no "information cost"--will beat stock picking. Hence, the chance of picking an undervalued stock is essentially random...and keeping trading to a minimum would be the way to go.
You're still not getting it: the efficient market hypothesis has no implications related to diversification at all.
No, you are the one not getting it.

Here's just one citation, from Investopedia. Google it...

Given the discussion on the EMH, the overall assumption is that no investor is able to generate an abnormal return in the market. If that is the case, an investor can expect to make a return equal to the market return. An investor should thus focus on the minimizing his costs to invest. To achieve a market rate of return, diversification in a numerous amounts of stocks is required, which may not be an option for a smaller investor. As such, an index fund would be the most appropriate investment vehicle, allowing the investor to achieve the market rate of return in a cost effective manner.

Retirement is a game best played by those prepared for more volatility in the future than has been seen in the past. The solution is not to predict investment losses but to prepare for them.

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Re: Is EMH a tautology?

Post by vineviz » Sun Oct 14, 2018 3:31 pm

Ron Scott wrote:
Sun Oct 14, 2018 3:08 pm
vineviz wrote:
Sun Oct 14, 2018 2:39 pm
Ron Scott wrote:
Sun Oct 14, 2018 2:36 pm
Uh boy... A major implication of the theory is that a diversified low-fee portfolio--with no "information cost"--will beat stock picking. Hence, the chance of picking an undervalued stock is essentially random...and keeping trading to a minimum would be the way to go.
You're still not getting it: the efficient market hypothesis has no implications related to diversification at all.
No, you are the one not getting it.

Here's just one citation, from Investopedia. Google it...

Given the discussion on the EMH, the overall assumption is that no investor is able to generate an abnormal return in the market. If that is the case, an investor can expect to make a return equal to the market return. An investor should thus focus on the minimizing his costs to invest. To achieve a market rate of return, diversification in a numerous amounts of stocks is required, which may not be an option for a smaller investor. As such, an index fund would be the most appropriate investment vehicle, allowing the investor to achieve the market rate of return in a cost effective manner.

Ron, that quote is confounding many different ideas (some of them outright incorrect) in what looks like an attempt at an argument supporting the use of index funds.

Which is fine: I like index funds and use several of them in my portfolio.

But the bit about diversification is completely out of left field in a discussion about EMH. The word ‘diversification’ appears just twice in Fama’s 43 page review article from 1991, and neither time as an implication of the theory.

https://onlinelibrary.wiley.com/doi/pdf ... .tb04636.x

Read that and tell me whether you still think your Googling gave you the right impression.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Is EMH a tautology?

Post by randomizer » Sun Oct 14, 2018 3:44 pm

Is the EMH "true"? Maybe, maybe not. But in terms of making investment decisions, the most rational thing to do is behave as if it were true.

Or to put it another way, I personally do not think it is technically "true", but I do believe that it is beneficial to consider it as up it were true.
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Re: Is EMH a tautology?

Post by rbaldini » Sun Oct 14, 2018 3:48 pm

Lauretta wrote:
Sat Oct 13, 2018 4:12 pm
Robert Shiller, who showed that EMH is nonsense...
How can one show that EMH is nonsense except by showing that its implications are false in the real world? If this is what he did, then it shows that the hypothesis is testable: the hypothesis makes false implications.

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Re: Is EMH a tautology?

Post by willthrill81 » Sun Oct 14, 2018 4:15 pm

The EMH, like most economic theories, assumes that information costs are zero. It also assumes that all information can be understood and acted upon by the market in total instantaneously. Obviously, that is false, and Fama seems to readily admit this point. It does seem to generally be a close-enough approximation to reality to be useful to the typical retail investor, and Fama appears to stick with this perspective (i.e. all models are 'wrong' on some level but some are useful).

My biggest issues with the EMH relate to my belief that the market, in total, does not always balance out one investor's bias with another investor's opposite bias (i.e. I do not believe that the sum total of all the biases in the market is always zero).
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Re: Is EMH a tautology?

Post by willthrill81 » Sun Oct 14, 2018 4:56 pm

triceratop wrote:
Sat Oct 13, 2018 5:47 pm
There is a good discussion between Thaler and Fama with Andrew Lo on Youtube, here.

Thaler presents what would otherwise be considered counterexamples of EMH but Fama dismisses their importance, claiming these anomalies as a clear error of the asset pricing model. There is discussion of the joint hypothesis. I don't want to get into too much detail at risk of mischaracterizing what they said.
Thanks for the link!

In that interview, from Fama (21:23):
The whole momentum phenomenon gives me problems. It could be risk, but if it's risk, it changes much too quickly for me to capture it in any asset pricing model. So that one gives me the biggest problems of all. So the point is not that markets are efficient. You know that they aren't; that's just the model. The question is how inefficient are they?
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Re: Is EMH a tautology?

Post by triceratop » Sun Oct 14, 2018 5:09 pm

^ Yes to be clear I was not referring to Momentum for one of Thaler's counterexamples. His are far more amusing, involving Cuba!
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Re: Is EMH a tautology?

Post by willthrill81 » Sun Oct 14, 2018 5:23 pm

triceratop wrote:
Sun Oct 14, 2018 5:09 pm
^ Yes to be clear I was not referring to Momentum for one of Thaler's counterexamples. His are far more amusing, involving Cuba!
Absolutely! But I thought it was worthwhile to point out that Fama admits that the momentum effect is in conflict with the EMH.
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Re: Is EMH a tautology?

Post by vineviz » Sun Oct 14, 2018 6:02 pm

willthrill81 wrote:
Sun Oct 14, 2018 5:23 pm
triceratop wrote:
Sun Oct 14, 2018 5:09 pm
^ Yes to be clear I was not referring to Momentum for one of Thaler's counterexamples. His are far more amusing, involving Cuba!
Absolutely! But I thought it was worthwhile to point out that Fama admits that the momentum effect is in conflict with the EMH.
He believes that there is a conflict

Saying that he admits it implies that his belief is true, which isn’t necessarily the case.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Is EMH a tautology?

Post by willthrill81 » Sun Oct 14, 2018 6:10 pm

vineviz wrote:
Sun Oct 14, 2018 6:02 pm
willthrill81 wrote:
Sun Oct 14, 2018 5:23 pm
triceratop wrote:
Sun Oct 14, 2018 5:09 pm
^ Yes to be clear I was not referring to Momentum for one of Thaler's counterexamples. His are far more amusing, involving Cuba!
Absolutely! But I thought it was worthwhile to point out that Fama admits that the momentum effect is in conflict with the EMH.
He believes that there is a conflict

Saying that he admits it implies that his belief is true, which isn’t necessarily the case.
I'm not sure what your point is. Mine was just that the creator of the EMH states that there is data out there that run counter to the EMH. He flat out said that markets aren't efficient.
Last edited by willthrill81 on Sun Oct 14, 2018 6:13 pm, edited 1 time in total.
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Re: Is EMH a tautology?

Post by Beehave » Sun Oct 14, 2018 6:11 pm

The Efficient Market Hypothesis (EMH) is an investment theory whereby share prices reflect all information and consistent alpha generation is impossible. (Investopedia)

I'm not sure what "all information" even means. If "all information" includes the sum of facts and emotions and beliefs of all market influencers and participants, I'd bet if given access to all of it someone could sort through it and beat the heck out of the market consistently.

If "all information" simply means information available to each market participant based on their perspective of it, then it is referring an average taken across the many, many, unequal individuals who comprise the buyers, sellers, and holders in the market. I'm not sure why that average is then being referred to as "efficient." It just is what it is.

Comparing EMH to a law of physics is misleading. What EMH is really saying is that absent having insider knowledge driving sure-bet transactions, and absent fear or greed or deliberate misinformation or coercion driving probable sure-fire-lose transactions, the average person is best served by setting an asset-allocation whose stock component is comprised of broad index funds and sticking with it by prudent rebalancing.

As an average investor myself, I've learned by experience (my own and observation of others) that this last description of EMH seems about right. But I'd then call it more a rule-of-thumb than a law.

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Re: Is EMH a tautology?

Post by vineviz » Sun Oct 14, 2018 6:51 pm

willthrill81 wrote:
Sun Oct 14, 2018 6:10 pm
vineviz wrote:
Sun Oct 14, 2018 6:02 pm
He believes that there is a conflict

Saying that he admits it implies that his belief is true, which isn’t necessarily the case.
I'm not sure what your point is. Mine was just that the creator of the EMH states that there is data out there that run counter to the EMH. He flat out said that markets aren't efficient.
My point is that by framing it as an admission is leading, implying both that it is a fact that there is conflict and that this alleged conflict is somehow embarrassing to Fama and/or the theory.

Fama is not the creator of EMH. It's a theory that predates him by generations, and I think it's important that people understand this not just the pet theory of one random professor somewhere.

Also, I think it's important to put his conclusions about whether markets are or are not efficient into context. I alluded to this earlier, where I quoted his 1991 paper (in which he wrote "Since there are surely positive information and trading costs, the extreme version of the market efficiency hypothesis is surely false."). This is not a matter of him dismissing the entirely theory as untrue, irrelevant, or event tautological. In fact, it's quite the opposite: it's merely an example of a man capable of discussing an economic theory with nuance.

After all, he goes on to say:
"The empirical literature on efficiency and asset-pricing models passes the acid test of scientific usefulness. It has changed our views about the behavior of returns, across securities and through time. Indeed, academics largely agree on the facts that emerge from the tests, even when they disagree about their implications for efficiency. The empirical work on market efficiency and asset-pricing models has also changed the views and practices of market professionals.

As these summary judgements imply, my view, and the theme of this paper, is that the market efficiency literature should be judged on how it improves our ability to describe the time-series and cross-section behavior of security returns. It is a disappointing fact that, because of the joint- hypothesis problem, precise inferences about the degree of market efficiency are likely to remain impossible. Nevertheless, judged on how it has improved our understanding of the behavior of security returns, the past research on market efficiency is among the most successful in empirical economics, with good prospects to remain so in the future."
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Is EMH a tautology?

Post by HanSolo » Sun Oct 14, 2018 7:40 pm

vineviz wrote:
Sun Oct 14, 2018 8:43 am
The following quote doesn't go into the full detail, but it should provide some (I hope) useful perspective. It's the first two paragraphs from Fama's 1991 review paper on the then-current state of research:
I take the market efficiency hypothesis to be the simple statement that security prices fully reflect all available information.
(snip)
I propose replacing "all available information" with "the aggregate of interpretations of all available information".

My version may still be a tautology, but at least it makes a better allowance for subjectivity and its consequences (like bubbles, irrational exuberance, etc.).

I like the earlier comment that efficiency is a spectrum. Maybe the hypothesis should be titled UREMH (Usually-Relatively-Efficient Markets Hypothesis).

As for usefulness, I like Buffett's adage better, that the market is a voting machine in the short term and a weighing machine in the long term. I understand it to mean that market irrationality, in most cases, affects short-term investors more than it affects long-term investors (I added "in most cases" because the folks who bought at the top of the tulip market also got burned in the long term).

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Re: Is EMH a tautology?

Post by willthrill81 » Sun Oct 14, 2018 7:50 pm

vineviz wrote:
Sun Oct 14, 2018 6:51 pm
willthrill81 wrote:
Sun Oct 14, 2018 6:10 pm
vineviz wrote:
Sun Oct 14, 2018 6:02 pm
He believes that there is a conflict

Saying that he admits it implies that his belief is true, which isn’t necessarily the case.
I'm not sure what your point is. Mine was just that the creator of the EMH states that there is data out there that run counter to the EMH. He flat out said that markets aren't efficient.
My point is that by framing it as an admission is leading, implying both that it is a fact that there is conflict and that this alleged conflict is somehow embarrassing to Fama and/or the theory.

Fama is not the creator of EMH. It's a theory that predates him by generations, and I think it's important that people understand this not just the pet theory of one random professor somewhere.

Also, I think it's important to put his conclusions about whether markets are or are not efficient into context. I alluded to this earlier, where I quoted his 1991 paper (in which he wrote "Since there are surely positive information and trading costs, the extreme version of the market efficiency hypothesis is surely false."). This is not a matter of him dismissing the entirely theory as untrue, irrelevant, or event tautological. In fact, it's quite the opposite: it's merely an example of a man capable of discussing an economic theory with nuance.

After all, he goes on to say:
"The empirical literature on efficiency and asset-pricing models passes the acid test of scientific usefulness. It has changed our views about the behavior of returns, across securities and through time. Indeed, academics largely agree on the facts that emerge from the tests, even when they disagree about their implications for efficiency. The empirical work on market efficiency and asset-pricing models has also changed the views and practices of market professionals.

As these summary judgements imply, my view, and the theme of this paper, is that the market efficiency literature should be judged on how it improves our ability to describe the time-series and cross-section behavior of security returns. It is a disappointing fact that, because of the joint- hypothesis problem, precise inferences about the degree of market efficiency are likely to remain impossible. Nevertheless, judged on how it has improved our understanding of the behavior of security returns, the past research on market efficiency is among the most successful in empirical economics, with good prospects to remain so in the future."
You seem wedded to the EMH, but I don't understand why. It's just a hypothesis, and for whatever role Fama played in it, he flat out said that markets aren't efficient and that what's in question is how inefficient markets are and can we identify inefficiencies a priori. But you seem to be doubling-down on this by insisting that the "theory predates him by generations" (source?) and that this statement of his is no reflection whatsoever on the validity of the EMH on any level. Thaler stated that the EMH is certainly useful even though he also believes it to be false on some level. I too have not disputed that the EMH is practically useful for the retail investor, but I dispute the oft-cited notion on this forum that the market instantly and perfectly prices in (whatever that means) every shred of available information instantaneously with every asset class every picosecond of every day (alright, that's a bit hyperbolic, but you get the point).
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Re: Is EMH a tautology?

Post by Phineas J. Whoopee » Mon Oct 15, 2018 2:54 pm

willthrill81 wrote:
Sun Oct 14, 2018 7:50 pm
...
You seem wedded to the EMH, but I don't understand why. It's just a hypothesis, and for whatever role Fama played in it, he flat out said that markets aren't efficient and that what's in question is how inefficient markets are and can we identify inefficiencies a priori. But you seem to be doubling-down on this by insisting that the "theory predates him by generations" (source?) and that this statement of his is no reflection whatsoever on the validity of the EMH on any level. Thaler stated that the EMH is certainly useful even though he also believes it to be false on some level. I too have not disputed that the EMH is practically useful for the retail investor, but I dispute the oft-cited notion on this forum that the market instantly and perfectly prices in (whatever that means) every shred of available information instantaneously with every asset class every picosecond of every day (alright, that's a bit hyperbolic, but you get the point).
Fortunately for the EMH it predicts no such thing, nor could it because there ain't none, and I'm not taking the hyperbole literally. Please read the link.

PJW

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Re: Is EMH a tautology?

Post by bertilak » Mon Oct 15, 2018 3:06 pm

randomizer wrote:
Sun Oct 14, 2018 3:44 pm
Is the EMH "true"? Maybe, maybe not. But in terms of making investment decisions, the most rational thing to do is behave as if it were true.

Or to put it another way, I personally do not think it is technically "true", but I do believe that it is beneficial to consider it as up it were true.
That's the way I look at it. The extent to which it is NOT true is not actionable -- by me anyway.

There are those who say, depend on someone else (smarter than you) to tell you what actions to take. Unfortunately, there is a lot of conflicting advice! That's another thing I am not smart enough to do -- selecting the right advice!
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Re: Is EMH a tautology?

Post by vineviz » Mon Oct 15, 2018 3:13 pm

bertilak wrote:
Mon Oct 15, 2018 3:06 pm
randomizer wrote:
Sun Oct 14, 2018 3:44 pm
Is the EMH "true"? Maybe, maybe not. But in terms of making investment decisions, the most rational thing to do is behave as if it were true.

Or to put it another way, I personally do not think it is technically "true", but I do believe that it is beneficial to consider it as up it were true.
That's the way I look at it. The extent to which it is NOT true is not actionable -- by me anyway.

There are those who say, depend on someone else (smarter than you) to tell you what actions to take. Unfortunately, there is a lot of conflicting advice! That's another thing I am not smart enough to do -- selecting the right advice!
I sometimes wonder if a famous economist said something like "if you step in front of a rapidly moving train then you're going to die" how long it would take for a Boglehead to show up and say "that's not 100% true, there's always a chance you could survive".

Then, how much longer would it take for someone else to point out that "nobody knows nothing about the future, so this prediction is nonsense"?
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Is EMH a tautology?

Post by alex_686 » Mon Oct 15, 2018 3:13 pm

vineviz wrote:
Sun Oct 14, 2018 2:39 pm
Ron Scott wrote:
Sun Oct 14, 2018 2:36 pm
Uh boy... A major implication of the theory is that a diversified low-fee portfolio--with no "information cost"--will beat stock picking. Hence, the chance of picking an undervalued stock is essentially random...and keeping trading to a minimum would be the way to go.
You're still not getting it: the efficient market hypothesis has no implications related to diversification at all.

There are OTHER important theories that have a lot to say about diversification, but EMH isn't one of them.
While EMH does not say anything about diversification, I though parts of diversification relied on EMH. I thought that one of the reasons why the market basket was the most efficient portfolio was because each of the components of the market basket where priced correctly. i.e, priced with expected return, risk, and any diversification benefit. Or am I missremembering something.

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Re: Is EMH a tautology?

Post by alex_686 » Mon Oct 15, 2018 3:22 pm

Lauretta wrote:
Sat Oct 13, 2018 4:39 am
In fact even Fama thinks that the momentum effect makes EMH very dubious, since one would need a particular crazy asset pricing model to justify the quickly shifting risk in momentum stocks. I saw a video in which Fama joked that he hopes that the momentum effect goes away, so that EMH will become more believable (or less incredible). Perhaps this gives an indication of how EMH should be taken, light heartedly and more as a joke, rather than with the seriousness and dogmatic attitude that many (who aren't equipped to think of the grounds on which it is built) have?
Is it a joke if it has come to pass? I have read a few academic articles showing that the momentum anomaly is no more.

Let me extend a bit.

First, I do find the statistics fascinating. Trying to prove these things one way or the other is hard. If we measure risk as the standard deviation we can get pretty close. However, the standard deviation of returns is time dependent. Plus, we know that markets have tail risk, that momentum has a higher tail risk then the general market, and that our estimates of that tail risk are at best vague. Sigh - why can't risk sit still so we can study it correctly.

Second, lots of anomalies in EMH have been found. What I find informative, and reinforces my belif in EMH, is that as soon as these anomalies are found they start disappearing. Maybe they were just statistical mirage in the first place. Or maybe once the market figured out the anomaly somebody decided to arbitrage that difference away. The Red Queen's Race.

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Re: Is EMH a tautology?

Post by bertilak » Mon Oct 15, 2018 3:38 pm

vineviz wrote:
Mon Oct 15, 2018 3:13 pm
bertilak wrote:
Mon Oct 15, 2018 3:06 pm
randomizer wrote:
Sun Oct 14, 2018 3:44 pm
Is the EMH "true"? Maybe, maybe not. But in terms of making investment decisions, the most rational thing to do is behave as if it were true.

Or to put it another way, I personally do not think it is technically "true", but I do believe that it is beneficial to consider it as up it were true.
That's the way I look at it. The extent to which it is NOT true is not actionable -- by me anyway.

There are those who say, depend on someone else (smarter than you) to tell you what actions to take. Unfortunately, there is a lot of conflicting advice! That's another thing I am not smart enough to do -- selecting the right advice!
I sometimes wonder if a famous economist said something like "if you step in front of a rapidly moving train then you're going to die" how long it would take for a Boglehead to show up and say "that's not 100% true, there's always a chance you could survive".

Then, how much longer would it take for someone else to point out that "nobody knows nothing about the future, so this prediction is nonsense"?
That's why I don't go looking for the fastest train.
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Re: Is EMH a tautology?

Post by MJW » Mon Oct 15, 2018 5:30 pm

vineviz wrote:
Mon Oct 15, 2018 3:13 pm
I sometimes wonder if a famous economist said something like "if you step in front of a rapidly moving train then you're going to die" how long it would take for a Boglehead to show up and say "that's not 100% true, there's always a chance you could survive".

Then, how much longer would it take for someone else to point out that "nobody knows nothing about the future, so this prediction is nonsense"?
I'm seeing a lot of recency bias here. Just because it was a train last time doesn't mean it will be in the future. It could be a bus. Or a herd of buffalo.

Am I doing it right?

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Re: Is EMH a tautology?

Post by vineviz » Mon Oct 15, 2018 5:40 pm

MJW wrote:
Mon Oct 15, 2018 5:30 pm
vineviz wrote:
Mon Oct 15, 2018 3:13 pm
I sometimes wonder if a famous economist said something like "if you step in front of a rapidly moving train then you're going to die" how long it would take for a Boglehead to show up and say "that's not 100% true, there's always a chance you could survive".

Then, how much longer would it take for someone else to point out that "nobody knows nothing about the future, so this prediction is nonsense"?
I'm seeing a lot of recency bias here. Just because it was a train last time doesn't mean it will be in the future. It could be a bus. Or a herd of buffalo.

Am I doing it right?
As long as you aren't running Monte Carlo simulations on the path of the trains and buses you're doing fine.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Is EMH a tautology?

Post by fortyofforty » Tue Oct 16, 2018 6:46 am

The oft-repeated mantra "Nobody knows nothin'" applies to the movement of the equity market--specifically short-term predictions as to the movement of stock prices--not to all fields of endeavor, I believe.
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Re: Is EMH a tautology?

Post by Valuethinker » Tue Oct 16, 2018 7:37 am

alex_686 wrote:
Mon Oct 15, 2018 3:22 pm


Is it a joke if it has come to pass? I have read a few academic articles showing that the momentum anomaly is no more.

Let me extend a bit.

First, I do find the statistics fascinating. Trying to prove these things one way or the other is hard. If we measure risk as the standard deviation we can get pretty close. However, the standard deviation of returns is time dependent. Plus, we know that markets have tail risk, that momentum has a higher tail risk then the general market, and that our estimates of that tail risk are at best vague. Sigh - why can't risk sit still so we can study it correctly.

Second, lots of anomalies in EMH have been found. What I find informative, and reinforces my belif in EMH, is that as soon as these anomalies are found they start disappearing. Maybe they were just statistical mirage in the first place. Or maybe once the market figured out the anomaly somebody decided to arbitrage that difference away. The Red Queen's Race.
I must admit I lean to the latter.

This is partly based on the belief in the track record of Renaissance Technologies (Jim Simon's & Robert Mercer's hedge fund). However there is an IRS case (not sure its status) which if the government wins, would seriously dent that performance record. Assuming for the moment that RT is on the level, they seem to have identified statistical patterns in the movement of assets that can be systematically exploited - the Phds of most of the main hires have been in computer speech recognition (signal pattern analysis) so that would be the clue.

AFAIK no one has ever duplicated what RT does.

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Re: Is EMH a tautology?

Post by tadamsmar » Tue Oct 16, 2018 8:28 am

Valuethinker wrote:
Tue Oct 16, 2018 7:37 am
This is partly based on the belief in the track record of Renaissance Technologies (Jim Simon's & Robert Mercer's hedge fund). However there is an IRS case (not sure its status) which if the government wins, would seriously dent that performance record. Assuming for the moment that RT is on the level, they seem to have identified statistical patterns in the movement of assets that can be systematically exploited - the Phds of most of the main hires have been in computer speech recognition (signal pattern analysis) so that would be the clue.

AFAIK no one has ever duplicated what RT does.
The IRS issue is that they treated short-term trading profits as long-term capital gains. I suppose the market could have short-term inefficiencies that survive because of the higher income taxes, so you could make much higher profits via tax evasion. Their best performing fund had all its profits going to the employees.

If I could treat my income as capital gains, then my income would effectively become 30% higher. That's close to RT's amazing performance numbers.

This link was the most I could find on RTs methods after some googling:

“If you’re going into quant trading, you have to really understand AI, math and statistics, because hedge funds prioritize having publicly available legal data that other people don’t see as useful,” Morgan says. “Learn AI and data science tools and have a deep understanding of stats."

https://news.efinancialcareers.com/us-e ... er-success

Note that RT made money in venture capital early on, but they apparently have recent decades of success in quant trading.

The curious thing is that their success does not seem to have been diluted by people leaving the firm and going out on their own. Their employee agreement has leaked and employees can compete one year after separation. An employee a 20-year named David Magerman left RT but I can't find that he went into competition with RT (I suspect he cut a side deal to drop a suit against RT and that may have kept him out of the business).

I think their secret is keeping their secrets by keeping their employees happy. The employees get half the profits and maybe that is the secret. An employee could at most double their money if they were an average performer, but by staying with the firm they get the diversification of profiting from all the other employee's ideas. Also, a massive amount of capital for computers and software must be involved and maybe some secret algorithms that employees can use without being able to fully reproduce.

Also the principals in the firm who get the other half of the profit are mostly techies, so they can keep some of the technical secrets closely held perhaps.
Last edited by tadamsmar on Tue Oct 16, 2018 9:08 am, edited 2 times in total.

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Re: Is EMH a tautology?

Post by Jeff Albertson » Tue Oct 16, 2018 8:58 am

As for momentum, Bob Young's contest with Bill Bernstein from 1997-2002 was an eye opener. Young frequently "traded" mutual funds using a momentum strategy. The results after five years (both bull and bear markets),
With an average annual return of 38.5% the Pony Express not only generated over 13
times the return of Bill's CRAAL portfolio but easily beat the return of every mutual fund
on the market over the duration of the contest. The Pony Express won nineteen of twenty
quarters as CRAAL was soundly and consistently defeated. The Pony Express made a deliberate
effort to try to win each and every quarter since Bill was comparing quarterly results.
intro: http://customer.wcta.net/roberty/INTRO.html
results: http://customer.wcta.net/roberty/fr-set-pe.html
Young, in practice, would could never trade as frequently as he did on paper, but never the less, quite impressive.

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Re: Is EMH a tautology?

Post by 3CT_Paddler » Tue Oct 16, 2018 9:19 am

There are a couple of basic tenets that make EMH superfluous to the Boglehead way...

1) Participants in large publicly traded stock markets are very good at comparing the immediate value and prospects of competing stocks/firms relative to one another.

2) Diversification is a free lunch for stocks, because the market is good at comparing stocks.

3) Costs matter. Whether it is management fees or transaction costs, what seems like small fees in isolation add up over long term timelines.

You don't need EMH to see the inherent value in a Boglehead approach. And one doesn't need to adhere to a strict version of Bogleheadism to make sound investment decisions.

The overall premium of all publicly traded stocks changes over time due to a myriad of human behavioral factors like perception of risk, fear of missing out, available capital to invest, foreign capital inflows and general market pessimism/optimism.

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Re: Is EMH a tautology?

Post by vineviz » Tue Oct 16, 2018 9:38 am

alex_686 wrote:
Mon Oct 15, 2018 3:13 pm
While EMH does not say anything about diversification, I though parts of diversification relied on EMH. I thought that one of the reasons why the market basket was the most efficient portfolio was because each of the components of the market basket where priced correctly. i.e, priced with expected return, risk, and any diversification benefit. Or am I missremembering something.
No, it really is two different concepts.

When people talk about the market basket being the "most efficient" portfolio, they are relying on implications of the Sharpe–Lintner-Black (SLB) CAPM in which all investors are assumed to prefer mean-variance optimal portfolios and in which unlimited lending and borrowing at the risk–free rate is possible. This model does flow directly from Markowitz's work on diversification, and in this context "efficient" means the market portfolio has the highest risk-adjusted return of all possible portfolios.

The efficient market hypothesis, on the other hand, is a theory that makes predictions not about the market portfolio as a whole but about the speed and completeness with which the market prices individual assets based on available information. EMH is more focused only on the cross-section of stock returns, whereas the SLB model has implications both for the cross-section of returns (which it doesn't explain very well, by the way) and the average risk and return of stocks.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

alex_686
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Re: Is EMH a tautology?

Post by alex_686 » Tue Oct 16, 2018 9:40 am

3CT_Paddler wrote:
Tue Oct 16, 2018 9:19 am
There are a couple of basic tenets that make EMH superfluous to the Boglehead way...

1) Participants in large publicly traded stock markets are very good at comparing the immediate value and prospects of competing stocks/firms relative to one another.

2) Diversification is a free lunch for stocks, because the market is good at comparing stocks.
So EMH is superfluous because you say the markets are efficient? Is that right? I feel like this is a affirmation of EMH, not an argument against.
3CT_Paddler wrote:
Tue Oct 16, 2018 9:19 am
3) Costs matter. Whether it is management fees or transaction costs, what seems like small fees in isolation add up over long term timelines.

You don't need EMH to see the inherent value in a Boglehead approach. And one doesn't need to adhere to a strict version of Bogleheadism to make sound investment decisions.

The overall premium of all publicly traded stocks changes over time due to a myriad of human behavioral factors like perception of risk, fear of missing out, available capital to invest, foreign capital inflows and general market pessimism/optimism.
[/b]
First, why is true? Second, are you sure? I will point out that funds with higher management fees have higher gross returns. You can't justify your end results by your end results. That is bootstrapping.

I will point out that the theory for passive investing is based on the theory that the market basket being highly efficient in terms of risk-rewards, and that theory is built on top of EMH. It is not superfluous, but rather foundational.

Maybe it is superfluous in the sense that electrons superflous to the lighting in my house. I get lighting in my house via a little switch on my wall. Since I get light from the switch on my wall, can I disclaim electrons?

alex_686
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Re: Is EMH a tautology?

Post by alex_686 » Tue Oct 16, 2018 9:55 am

vineviz wrote:
Tue Oct 16, 2018 9:38 am
The efficient market hypothesis, on the other hand, is a theory that makes predictions not about the market portfolio as a whole but about the speed and completeness with which the market prices individual assets based on available information. EMH is more focused only on the cross-section of stock returns, whereas the SLB model has implications both for the cross-section of returns (which it doesn't explain very well, by the way) and the average risk and return of stocks.
hmm. I might have to step back and think about what I have said and do some more reading. Thanks for your input.

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tadamsmar
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Re: Is EMH a tautology?

Post by tadamsmar » Tue Oct 16, 2018 10:10 am

vineviz wrote:
Tue Oct 16, 2018 9:38 am
The efficient market hypothesis, on the other hand, is a theory that makes predictions not about the market portfolio as a whole but about the speed and completeness with which the market prices individual assets based on available information. EMH is more focused only on the cross-section of stock returns, whereas the SLB model has implications both for the cross-section of returns (which it doesn't explain very well, by the way) and the average risk and return of stocks.
If the SLB has implications for the cross-section of returns and the EMH is focused on that, then the EMH is about the market as a whole. A stock is priced based on its role in a portfolio with optimal risk-adjusted return, assuming it is rationally priced. You have to take variance and covariance with other stocks into account when determining the correct price for a stock.

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3CT_Paddler
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Re: Is EMH a tautology?

Post by 3CT_Paddler » Tue Oct 16, 2018 10:24 am

alex_686 wrote:
Tue Oct 16, 2018 9:40 am
3CT_Paddler wrote:
Tue Oct 16, 2018 9:19 am
There are a couple of basic tenets that make EMH superfluous to the Boglehead way...

1) Participants in large publicly traded stock markets are very good at comparing the immediate value and prospects of competing stocks/firms relative to one another.

2) Diversification is a free lunch for stocks, because the market is good at comparing stocks.
So EMH is superfluous because you say the markets are efficient? Is that right? I feel like this is a affirmation of EMH, not an argument against.
Where did I say EMH? Saying stock markets are very good at comparing relative value between companies is not the definition of EMH or the way it is used to say you cannot capture market mispricing. I don't know if EMH is a correct hypothesis, but you don't need it to be correct (particularly the strong form) in order to have confidence in a low cost, diversified approach to investing. Why do you object to that very basic idea?
alex_686 wrote:
Tue Oct 16, 2018 9:40 am
3CT_Paddler wrote:
Tue Oct 16, 2018 9:19 am
3) Costs matter. Whether it is management fees or transaction costs, what seems like small fees in isolation add up over long term timelines.

You don't need EMH to see the inherent value in a Boglehead approach. And one doesn't need to adhere to a strict version of Bogleheadism to make sound investment decisions.

The overall premium of all publicly traded stocks changes over time due to a myriad of human behavioral factors like perception of risk, fear of missing out, available capital to invest, foreign capital inflows and general market pessimism/optimism.
[/b]
First, why is true? Second, are you sure? I will point out that funds with higher management fees have higher gross returns. You can't justify your end results by your end results. That is bootstrapping.

I will point out that the theory for passive investing is based on the theory that the market basket being highly efficient in terms of risk-rewards, and that theory is built on top of EMH. It is not superfluous, but rather foundational.

Maybe it is superfluous in the sense that electrons superflous to the lighting in my house. I get lighting in my house via a little switch on my wall. Since I get light from the switch on my wall, can I disclaim electrons?
So costs don't matter? I appreciate the snarky response, but you didn't refute the basic conclusions stated.

Bogle came up with his approach prior to Fama's EMH, based on what he now calls the Costs Matter Hypothesis. This isn't rocket science, and Bogle himself was the one who put these ideas forward.
https://www.vanguard.com/bogle_site/sp2 ... Mrkts.html
We don’t need the EMH to explain the dire odds that investors face in their quest to beat the stock market. We need only the CMH. Whether markets are efficient or inefficient, investors as a group must fall short of the market return by the amount of the costs they incur. And since the cost of our intermediation system is relatively stationary over short periods, the impact of that cost is inversely correlated with the returns on stock prices (i.e., a 3% annual cost would consume one-fifth of a 15% market return, but fully one-half of a 6% return.) Even for investors who incur more modest costs (say, 1% per year), the odds are that 95% of them will fail—often by huge amounts—to earn the stock market’s return over an investment lifetime.

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