Do you believe in Efficient Market Theory (EMT)?You're familiar with the old joke about the economist who won't pick a twenty-dollar bill off the sidewalk, because if it were really there someone would have picked it up already. All right. So Efficient Sidewalk Theory (EST) says that there are no twenty-dollar bills on the sidewalk, because they've been picked up. Efficient Sidewalk Theory shares the defect of Efficient Market Theory that if everyone believed it absolutely, like the economist in the joke, then no one would pick up twenty-dollar bills and they would accumulate on the ground. But, although an absolute belief in Efficient Sidewalk Theory leads to absurdity, nevertheless I would say Efficient Sidewalk Theory is substantially true. Almost no sidewalks have twenty-dollar bills on them, because of the tendency for passers-by to pick up the bills. Practical consequences: Although I'll pick up a twenty-dollar bill if I see one, I'm not inclined to go on long walks in order to look for one. And if someone wrote a book about their "system" for finding dropped bills ("check near ATMs and outside stores," "go looking in January when people have cold fingers and wear gloves"), I would be inclined to think that, while their system might have some merit, it probably does not have a lot of merit, because of Efficient Sidewalk Theory. So, I believe in EMT if the stockmarket is like a sidewalk. The thing is, though, that the sidewalk represents an extreme case where all the actors have a very easy time detecting and removing any inefficiencies. It's not clear that this is true in the stockmarket. A couple more EMT-type hypotheses in situations other than the financial markets: Theory: When driving on a crowded freeway, it doesn't matter what lane you're in. There are thousands of other drivers on the road with you, all trying to get out of the slower lanes and into the faster lanes. So on average all the lanes will move at the same speed, or at least it's impossible to predict which lanes will move faster at any given time. You might as well just stay in whatever lane you're in and avoid switching costs. Theory: The efficient labor market means that all jobs are equally rewarding. For each job, the salary and any fringe benefits must precisely compensate for the specific headaches and necessary preparation for that job. Or, if some jobs do carry outsized rewards, it's a matter of dumb luck which jobs those turn out to be. So any time spent deciding on a career is really time wasted. You might as well choose your career by pulling it out of a hat, on average you'll have just as good a life without wasting effort on research. Reflecting on these theories, it seems to me that there is at least a grain of truth in them. It does sometimes seem that changing lanes in a traffic jam is a waste of time and whichever lane you get into becomes the slow one. But on the other hand I wouldn't stake my life on these theories either. For example, if there is actually a wreck blocking your lane up ahead, you'll have to change lanes sooner or later and probably the earlier you realize this the better off you are. |