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Efficient Markets Theory
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In other words, it was strongly believed by everyone involved that the efficient markets theory provided what can only be described as an informational free lunch. For the cost of establishing a market in traded securities (which is something that an advanced capitalist society would have to do anyway, in order to provide the convenience to investors of being able to convert their claims on long-term investment projects into liquid funds), we could gain, Ginsu-knives-style, a Delphic oracle that would ... give s free information about the future and about cash flows. Belief in the existence of this sort of informational free lunch, by the way, is at the heart of James’s book “The Wisdom of Crowds”, and will also be at the heart of my review essay on it, which I am still procrastinating. Suffice it to say that the use of the phrase “free lunch” is intended to make the reader suspicious as to whether one should uncritically accept such a miraculous and politically convenient (for a number of people) piece of theorising as the efficient markets concept.
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In terms of the efficient markets theory, do you feel that large institutions are the only ones that have the resources to do the research and exploit any inefficiencies? That this is the reason why the rest of us—the individual investors, the majority—can’t beat the market?
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At first blush, the efficient markets theory seems a reasonable way to predict elections. Think about it: If a pollster calls you up and asks you who you plan to vote for or who you think will win, you have little incentive to carefully consider your answer. Maybe you say you'll vote for Bush or Gore, but when Election Day comes around, you never make it to the voting booth. Maybe you aren't a very representative voter. These are the intangibles that have driven generations of political scientists crazy.
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A central issue in the analysis of markets is the degree to which they are efficient. Although ‘efficiency’ has a variety of meanings in different contexts, a situation is sometimes termed ‘efficient’ if it is not possible to increase the well-being (utility) of any one person without reducing the utility of another. This is usually referred to as Pareto efficiency. An implication of Pareto efficiency is productive efficiency, a situation which exists when it is not possible to increase the quantity produced of any one good without reducing the quantity produced of another.
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This paper is an application of efficient markets theory to analyze empirically the relationship of money supply growth and long-term interest rates. This approach has the advantage over earlier research on this subject in that it imposes a theoretical structure on this relationship that allows easier interpretation of the empirical results as well as more powerful statistical tests. In the interest of ascertaining the robustness of the results, many different empirical tests are carried out in this paper, and they uniformly do not support the proposition that increases in the money supply are correlated with declines in long rates.
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While researchers in behavioral finance continue to develop advanced models of the interplay of psychology and finance, proponents of efficient markets will continue to probe the relationships between risk and return. The debate is far from over.
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Efficient Markets Theory