I did a brief review of this lit for a paper I wrote recently. Some comments:
1. If market efficiency has any substantive relationship to "real" factors (as revealed ex post), unpredictability of price movements is necessary but not sufficient for efficiency.
2. The only defensible claim about financial markets is that they are unpredictable in the their first moment (directionality). Schiller et al., as well as common sense, suggest that the higher moments (overshooting) are predictable. This is just another way of saying that an informed observer (like Doug) can tell you when the market is over- or undervalued (with better than 50% probability) but not when to get out or in.
3. If people make consistent errors of judgment (there is lots of evidence that they do), today's price could always be the best estimator of tomorrow's and yet the market would be inefficient according to some objective standard. In other words, both today's price and tomorrow's can be irrational.
None of this is very profound, but sometimes the semantics of this topic obscures the more-or-less simple underlying concepts.
Peter
Doug Henwood wrote:
Devine, James wrote:
BTW, the stock market is basically unpredictable _even though_ it doesn't fit the "efficient markets" hypothesis.
Again, I must turn into a pedant and ask just what you mean by that. There are several forms of the EMH. Quoting myself from Wall Street, characterizing Eugene Fama's review:
Fama distinguished among three varieties of the EMH: the weak, semi-strong, and strong forms. The weak form asserts that the past course of security prices says nothing about their future meanderings. The semi-strong form asserts that security prices adjust almost instantaneously to significant news (profits announcements, dividend changes, etc.). And the strong form asserts that there is no such thing as a hidden cadre of "smart money" investors who enjoy privileged access to information that isn't reflected in public market prices.
This isn't entirely nonsense, is it? Would you argue that stock prices don't adjust almost instantaneously to fresh news? Would you argue that there isn't a strong element of randomness in prices? If you say the market is basically unpredictable, then you're subscribing to at least part of the EMH.
The anomalies that have been identified over the years - that low P/E stocks outperform high P/E ones, for example - imply that stocks are, at least to some degree, predictable. The same with Shiller's work on overreaction, which implies that speculators who bet against extremes of mob psychology (which is essentially the strategy of both Keynes and Soros) are part of a smart money cadre that aren't trading on the basis of nonpublic information, but on an unpopular analysis.
You could say that the market efficiently reflets the often nonsensical consensus of investors, which is something EMH types wouldn't agree with. Even some dissidents have a problem with irrationality. The first time I met Joseph Stiglitz was late in the dot.com mania. I was very curious to hear his analysis of that lunacy. But his info theory still holds that investors are rational, just not all equally informed. So he wondered aloud, "Why do people buy those stocks?"
Doug
