From the New Yorker:
The Inefficiency of the Market Isn’t an Open Question
In an article on the front page of Tuesday’s Times, Binyamin Appelbaum did a nice job of highlighting the difference in views between Robert Shiller and Eugene Fama, who shared this year’s economics Nobel memorial prize with Lars Peter Hansen. But there’s a danger that some readers may come away from the article, and other news coverage of the prize, with the impression that the issue of whether financial markets are efficient remains unsettled. It isn’t. After living through a stock-market bubble and a credit bubble in the past decade and a half, we can be quite sure that financial markets are sometimes chronically inefficient. The only outstanding question is how far this inefficiency extends.HT: The Reformed Broker
Discussing the Nobel committee’s decision to honor Shiller and Fama in the same year, Appelbaum quotes Justin Wolfers, an economist at the University of Michigan: “It encapsulates the state of modern economics,” Wolfers says. “We have big important questions that remain largely open, and we have giants bringing evidence to bear. And the answer turns out to be more complicated than markets are efficient—or markets are inefficient.” On top of teaching and doing his own research, Wolfers, through his columns at Bloomberg View and his regular presence on Twitter, does a yeoman’s job in helping to educate the public about economics. I often learn from him. But I fear he erred in this instance. Neither Fama nor Shiller are intellectual giants. They are both smart, empirically-minded professors who did influential and important work. Putting them on a pedestal serves no purpose. Also, as I said in opening, the question of financial-market efficiency is no longer an open one. In anything but the narrowest technical sense, which conflates efficiency with predictability, it has been settled in the negative.
Part of the problem is how financial economists define efficiency. In most areas of economics, efficiency is defined in terms of how well markets allocate resources. If a given market allocates them in a way that leaves it impossible to increase the welfare of one person without lowering the welfare of at least one other person, the market is said to be “Pareto efficient.” One of the big achievements of twentieth-century economics was in showing how, under certain highly restrictive conditions, a free-market economy can produce a Pareto-efficient outcome.
Since the nineteen-sixties, when Fama got his start, financial market efficiency has been defined rather differently. According to Fama’s definition, which quickly became the standard one, a financial market is “weak-form efficient” if prices reflect all the past information that is relevant to the market, such as the history of price movements. The market is “semi-strong-form efficient” if it reflects all past and current public information. And it is “strong-form efficient” if it reflects all the public and private information.
Since the stock market can’t talk, we can’t ask it if the price of I.B.M.’s stock fully reflects the latest developments at I.B.M.’s research facilities. (Even if markets could talk, they might not tell us the truth.) Rather than gauging market efficiency directly, economists have concentrated on testing certain narrower theories that appear to be corollaries of efficiency. For example, weak-form efficiency implies that technical analysis (“chartism”) can’t be used to beat the market. Strong-form efficiency suggests that all fundamental stock analysis, of the sort frequently carried out in brokerage and fund-management firms, is pointless. Since efficient markets reflect all information practically instantaneously, the deductions the analysts are making are already reflected in the price.
It was clear from the very beginning that this notion of efficiency is problematic. On a theoretical level, it can be, at best, a rough approximation. If markets are strong-form efficient, it is a waste of time and effort for anybody to pore over quarterly reports or articles about industry trends. But if nobody does this sort of information-processing, how does new information get incorporated in prices? As Joseph Stiglitz and Sanford Grossman pointed out way back in 1975, a perfectly efficient market is an impossibility....MORE
*IBM beat analyst earnings by 3 cents but missed on the top line with revenues coming in a billion dollars light
(but hey, that means margins were better than expected, right?)
In after hours trade the stock was down $11.28 (6.04%) at $175.45.
The stock had traded up $2.07 during the day.
Weak form? Semi-strong form?
Either way that's a negative 72 point contribution to the Dow Jones Industrials all on its lonesome should the stock open there tomorrow.
