Behavioral Finance Lecture 04: Far-from-equilibrium dynamics and the empirical failure of CAPM
on August 24th, 2011 at 9:51 pm
The CAPM and EMH stick to the neoclassical script of believing that the economy and finance markets are stable, at or near equilibrium, and on this basis argue that “you can’t beat the market”. But there is an alternative view, far more aligned with the actual data, that says that markets are chaotic, far from equilibrium systems, and for that reason it’s very hard to beat the market.
Eugene Fama was an enthusiastic promoter of CAPM and the Efficient Markets Hypothesis, arguing that despite their absurd assumptions, the data supported the theories. But was this a fluke, the result of the narrow data range he used–from 1950 till 1966?
He has since disowned the theory in 2004, stating that “the theory has never been an empirical success”, and that “most applications of the theory are invalid”. But somehow these honest statements don’t seem to have made it into the finance textbooks.
Here are the Powerpoint files for this lecture: Part 1; Part 2.
@ Lyonwiss August 25, 2011 at 9:55 pm | #
Thank you – your answer is exactly as I anticipated and that which I sought. And now, HFT is in everything and all markets: tell me where the value lays, or lies.
@ Lyonwiss August 25, 2011 at 11:13 pm | #
“Alainton August 25, 2011 at 6:25 pm
I’m not sure “anarcho-capitalist” is an accurate term to describe the view that corrupt government is colluding with banksters to prevent the proper functioning of capitalism, against the interest of most people.”
I guarantee that it is the wrong terms entirely; the correct term is “Fascism” which is what the Global “leadership” of the day has fully embraced , which is nought but rule by that which comes out of the barrel of a gun, war, genocide and applied “economic theory(ies)” as we know it.
It is also called, sadistic stupidity in denial. It could also be called natural corruption of the sewer classes ie “leadership”.
Alainton: please be careful with your choice of words and terms: they have meaning and histories and lives of their own.
But there is another window open to Bankers… which you may consider as a weapon? I do!
@Alainton…
Thought your last post summed up the current situation quite well. Political will has become a predominant factor. A few years back, someone proposed a path we will follow – and so far that path has yet to be incorrect. It is financial crisis = soveriegn crisis = political crisis = currency crisis. Just food for thought of course. Thank you again for the reading material. Always appreciated.
@PJB
Simply using the words Rothbard and the younger Freidmann use to describe themselves. Though it rightly gets the back up of true anarchist lefties.
“Spam is a better hedge against inflation than gold: you can eat it and it lasts 1000 years” Roubini
Invest in it PJB, you seem to favour it.
“That is, it is hard to argue simuatenously that debts matter – but stimulus would have been better if it was of much greater magnitude”
how so centreline
@ Centerline August 26, 2011 at 12:06 am | #
May I add: socio-economic crisis – ethical crisis – morality crisis – humanity crisis – integrity crisis – rationality crisis – intellectual crisis.
Thank you
“The only ‘conventional’ weapon left to central bankers is monetary expansion – but the political will to do so isnt there – certainly before such a crash”
that horse has well and truely bolted alainton
not where short term rates are at zero like the US,
they can have a crack at lowering yields on longer term debt,
after that they are out of bulletts, and they can spend their days watching reserve balances grow
probably a bit more exciting than watching the grass grow
“Thought your last post summed up the current situation quite well. Political will has become a predominant factor. A few years back, someone proposed a path we will follow – and so far that path has yet to be incorrect. It is financial crisis = soveriegn crisis = political crisis = currency crisis”
well in europe yes, but monetary union is fundanentally flawed,
theyve been trying to unify europe for two thousand years, it never turns out well
where as in the case o f the americans, its just sheer stupidity and negligence in mis understanding the power a sovereign currenct bestows upon a nation, and spending the last 250 years bailing out bankers
@ Alainton August 26, 2011 at 12:09 am | #
@PJB
I believe that you are attempting to compromise me, categorised me, as well as goad me, young grasshopper.
I am, for your information, a Man. Definitely not less – nor more. But an extremely experienced Man (your imagination could not stand the impact of my life’s history), an Individual, and an Heretic!
I have eaten far worse than Spam – dark green greasy canned meat produced by the government approved suppliers to the warriors of war – we used to call it “green shit”. But we were hungry; so we survived; some of us survived. In the jungle and the desert it could be smelt from miles away. To survive: and in the end; we didn’t open the cans. Economics at work.
Spam would have been a luxury in my earlier days and Roubini is still to this day, a self-serving clown!
I only invest in myself Alainton; this is true economics!
@ Mahaish August 26, 2011 at 12:27 am | #
The conventional weapeon that is left is War!
They have tried Atomic War,
Now, they want to try Nuclear War!
Now they will try Nuclear War! It is the way of the Economists!
sirius – don’t understand what, the markets?
More likely it’s randomness which is not understood. You may be able to explain every fluctuation in the market, but from a purely statistical perspective markets are random.
TITINT
Markets – random ???
1)
Buffet buys 5 billion of BAC and gets some special “preferences”…
http://market-ticker.org/akcs-www?post=192968
2)
And the following sort of “fits the bill”…
“”
@peterm99: I think you’re suggesting (as KD has often done) that housing prices cannot inflate beyond 3x-5x income without crashing – false. That presupposes a stable reserve currency, which we haven’t had for 30 years.
You must consider the “big picture” overall operating environment of the FED, and other central banks.
The central banks can create inflation in any asset class they choose, regardless of income, forever. The fact that food/fuel/housing becomes unaffordable is an unfortunate result, but only impacts certain segments of the economy/people.
The system will never “crash” (as it did)until and unless massive fraud is uncovered – the central banks can simply print more money, the rich get richer, and the poor suffer since their income cannot buy necessities, but a global crash of virtually all asset classes at once? – not a chance.
Am I wrong?
“”
http://market-ticker.org/akcs-www?post=192945#discuss
(My bold)
3)
As the write of Liar’s poker mentioned…
“”
But he’d spent his life in the stock market, and it was clear that the stock market was, in this story, largely irrelevant. What most people don’t realize is that the fixed-income world dwarfs the equity world, he says. The equity world is like a fucking zit compared with the bond market.
“”
http://www.gatsby.ucl.ac.uk/~pel/misc/The-End-of-Wall-Streets-Boom.html
Believe what you want. From where I am sitting “the market” is clearly not random and I am not even scratching the surface.
You are viewing a modernised “image” of what appears to be the “good old stock markets” where men got together and considered ideas and what to back (put money into). The scene appears familiar to make you think that nothing has really changed.
Now you have all sorts of computers, high-speed data links, ‘bots and many other “specialist devices” that did not exist before (unless you call a horse a specialist device).
I have no wish to attempt to convince anyone. If things are not obvious to people with all that has now become extremely evident then it is unlikely you will see.
I believe Bernie Madoff was involved in the creation of the NASDAQ. Do you see any relationships.
Insider trading is legal for the members of US congress.
…
@TITINT
You reminded me of an experiment where a group of students were asked if they could find any form of intelligent communication in a certain part of a radio frequency (a band near 2.0 GHz).
The students reported that all they could find was “noise” (random) – no sign of intelligent communication.
In which frequency band were they looking ?
In one of the the frequency bands for mobile phones which uses “spread spectrum” techniques.
Sirius, like I said, there is an explanation behind every fluctuation, but that does not make markets non statistically random. You’re making an unnecessary link between information and the statistical property of the price series.
From an EMH perspective, if markets were efficient then they would necessarily be random. However, inneficient markets are not necessarily not-random, statistically speaking.
On your point 1) A person who controls $5b will inevitably get preferential treatment and can also move markets. For that instance, from his perspective the market is not random. From a purely statistical perspective, it is a random event.
2) Same as point 1), the Fed controls money, they have the power to move markets. Same answer applies as above.
3) Bond markets ‘dwarf’ equity markets, well done Captain Obvious! And the link to randomness, ok – Bond Markets > Equity Markets therefore markets are not random, right…
Random does not mean not exploitable, this is a false conclusion from the misinterpretation of EMH. The very particles we are made of behave randomly, and yet we are able to exploit this to enjoy our little self important moment in the sun’s 4.5 billion year history.
Lack of understanding of randomness is the problem here.
@TITINT
“Lack of understanding of randomness is the problem here.”
Thank-you for the points you raised.
That time when you know that you are doomed by your “leadership”.
“A New York Times piece captured the feel-good mood of that 2009 meeting:
Central bankers from around the world expressed growing confidence on Friday that the worst of the financial crisis was over and that a global economic recovery was beginning to take shape…
Speaking to central bankers and economists at the Fed’s annual retreat here in Grand Teton National Park, Mr. Bernanke echoed the growing relief among European and Asian central bankers that their own economies had already started to rebound.
end/quote
I have taken this from today’s Daily Reckoning newsletter.
Inspirational stuff what? I’m sure that you all will now feel safe and warm knowing that your interests are in the hands of these Supra-intellectual Economists.
“And, in the morning, we shall remember them.”
@ Sirius August 26, 2011 at 10:04 am | #
@TITINT
“Lack of understanding of randomness is the problem here.”
And there my dear Sirius is the fundamental problem with Economics.
1. No Economist knows what “Economics” is, nor what “money” is, or even wants to know,
2. Economics, that is to say, those things and applications which revolves around ‘Economic Theory” in matters of running the whole of our global societies, do not account for Human Behaviours, that it, it is pure theoretical computation without people and therefore is essentially nonsense,
3. As such, all ‘practical’ and functioning matters Economic, are run by manipulation, preference, convenience and opinion and far more often than not, by Moral Hazard.
Therefore as I have said before, playing around with formulae and mathematics, is something akin to the Bankers wet dream du jour, ‘mark to fantasy’.
So “random” does actually mean “spontaneous” in reality.
“Nobody could have seen this coming.” — Ha!
@TITINT
Me and my 100 mates are on a cruise ship. At 12.00 we all decide to simultaneously walk to the same side of the ship. The ship tips over like in the movie the greatest show on earth.
A statistician watching it would say wow, the normal Brownian motion produced an incredibly rare outlier.
Me and my mates know we have just sunk a ship.
Its events like that which disprove to me the idea of subjective probability. Its an illusion cause by the scale and reference frame of the observation.
Alainton, the only issue there is your poor choice of probability distribution.
Log normalness is one of infinately many applicable probability distributions, it does have some specific properties which make it popular. However it is questionable as a model choice for your party cruise, particularly if all 100 men movements are suddenly highly correlated.
If you are making a comparison to default correlation risk, then this is best modelled explicitely as default correlation, as opposed to implicitly from the distribution of the underlying assets.