The Efficient Market Hypothesis, according to Shiller, is one of the most remarkable errors in the history of economic thought. EMH should be consigned to the dustbin of history. We need to stop teaching it, and brainwashing the innocent. Rob Arnott tells a lovely story of a speech he was giving to some 200 finance professors. He asked how many of them taught EMH - pretty much everyone's hand was up. Then he asked how many of them believed it. Only two hands stayed up!
And we wonder why funds and banks, full of the best and brightest, have made such a mess of things. Part of the reason is that we have taught economic nonsense to two generations of students. They have come to rely upon models based on assumptions that are absurd on their face. And then they are shocked when the markets deliver them a "hundred-year flood" every 4 years. The models say this should not happen. But do they abandon their models? No, they use them to convince regulators that things should not be changed all that much. And who can argue with a model that was the basis for a Nobel Prize?
I am again out of town this week, but I have been saving a speech done by my friend James Montier of Societe Generale in London on the problems with the Efficient Market Hypothesis (EFM). While parts of it are wonkish, there are also parts that are quite funny (at least to an economist).
Ideas have consequences, and bad ideas usually have bad consequences. The current maelstrom from which we are emerging (finally, if in fits and starts) has many culprits. A lot of bad ideas and poor management that came together to create the perfect storm. Today, we look at some of the ideas that are part of the problem but are too often glossed over because they are "academic" and not of the real world. However, gentle reader, academic ideas that are taught and accepted as gospel by 99% of the professors have real-world consequences. Where does your money manager stand on these topics? It does make a difference. And now, let's jump into James's speech.