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The Efficient Market Hypothesis Won't Rise From the Ashes


It can't survive in its current form because it deliberately excluded the human behavior component at the peak of economic pragmatism.

The Efficient Market Hypothesis (EMH) is not only dead, it's really, most sincerely dead. In fact, one could argue that an excess volatility tornado caused a bank-owned house to land on its head and kill it once and for all.

While James Kostohryz suggests that only "Nietzschean, populist, anti-intellectual" munchkins waving pitchforks and torches are proclaiming "ding-dong the wicked EMH is dead" in between their tea party meetings, the truth is that it was killed by rigorous academic analysis throughout the 1980s and 1990s led by Schiller (Yale), and Lo & McKinlay (MIT). Academia completely turned its back on EMH following the Asian crisis in the late 1990s.

See Kostohryz's Are the Efficient Market Hypothesis and the Concept of Fundamental Value Dead?

EMH came into vogue in the early 1970s at the height of what is now referred to by Behavioral Finance as the "rational expectation revolution" of economic theory. EMH postulated that efficient markets always incorporated the best information about fundamental values and prices only changed because of good, sensible information. The three base assumptions of EMH were:

1. Investors are rational.
2. Random irrational Investors neutralize each other out.
3. Rational arbitragers take care of all remaining inefficiencies.

While it's true that fundamental analysis is separate from EMH, it was highly promoted along with the combined EMH/ RWT neatly packaged theoretical economic model. Guilty by association I suppose.

While EMH came in three flavors, weak, semi-strong, and strong, only the weak version, for which I provided a definition in my previous article, was supportable by econometric time series analysis (i.e. empirical evidence) to begin with.

I also explained that while academia attempted to discredit "folksy" old technical analysis, it only succeeded in moving it out of mainstream academic study and into investment houses and their associations.

In the professional world of finance, a Chartered Market Technician (CMT) is to technical analysis what a Chartered Financial Analyst (CFA) is to fundamental analysis. Both designations are widely considered graduate level self-study coursework based on three levels of testing and sponsorship by existing members. Both designations are equally recognized by the National Association of Securities Dealers.

Technical analysis does have deep roots in America. Charles Dow went on to form the Dow Jones Company and was the first to publish stock prices publicly, which enabled private traders and investors to observe and track price movement for the first time. Tracking, mapping, tabulating, and interpreting price movement became a thriving growth industry that boomed in the early 1900s and continued to flourish during the Great Depression. Other early companies that got their start in technical analysis include Standard Statistics (published A/D line), which later merged with Henry Poor's technical analysis company to form Standard and Poor's.
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No positions in stocks mentioned.

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