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Split Thread Are markets rational?

Basically, efficient market hypothesis is that an asset price reflects available information. Therefore it isn't possible to outperform the market unless one has superior information.

That is the hypothesis, but I don't think it's always true. Can it explain the price of artwork or bitcoin? Or the value of Theranos or FTX at their respective peaks? I believe that there is a sort of bubble mentality around Silicon Valley tech companies. You also saw it in the "dot.com bubble" And the housing bubble of the 2000's. (Michael Lewis wrote about some people who saw it coming in "The Big Short".)

Sometimes the "available information" may exist and be public, but still a lot of people don't understand its significance.
 
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I think everyone would agree that it's not always true. In fact, it's never 100% true. What's surprising is how well it works in many major asset markets.
 
But the "Efficient Market Hypothesis" is nonsense.

A market is rational in the same way a gambler is rational. Normally we would say that someone who buys a lottery ticket is not rational because there is effectively no chance of a return but in economics the person buying a lottery ticket is rational because they get something, not money, out of the transaction.
 
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To be more accurate, there are some people who, despite all the evidence, think that capitalism is a good basis for an economy. And no, I am not neccessarily against private enterprise; in the correct place and with the correct constraints it is a powerful tool to be used.

But that's the problem with capitalism, its one rule dictates that no constraints should be placed on the owners of capital and that all rewards from said capital should be solely theirs to dispose of.

Why else do you think that all major economies are a mixture of private and public? Capitalism has been tried, multiple times (most notably in Soviet Russia) and has always been found wanting.

Soviet Russia was Capitialistic??????
Please, no the "State Captialism" garbage, which is just an excuse by the true beleivers in Marxism as to why Marxism failed so badly when tried.
AKA "Communism is a wonderful idea, only the right people have not tried it yet".

You want to disagree with reality, that's your prerogative. But then again this attitude is why classical economics is so divorced from reality.
 
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That is the hypothesis, but I don't think it's always true. Can it explain the price of artwork or bitcoin? Or the value of Theranos or FTX at their respective peaks? I believe that there is a sort of bubble mentality around Silicon Valley tech companies. You also saw it in the "dot.com bubble" And the housing bubble of the 2000's. (Michael Lewis wrote about some people who saw it coming in "The Big Short".)
I agree that "bubbles" really demonstrate that the hypothesis is false. During the original dot.com bubble we (company I was a director at) went public - because we knew the valuations were totally *******, we raised - it seems paltry these days - just over £21 million, the company was by any rational assessment of its earnings potential, profitability, risk and so on worth around £6 million tops.

Sometimes the "available information" may exist and be public, but still a lot of people don't understand its significance.

That and of course the good old "emperor's new clothes" syndrome - if other investors are heavily investing in a sector and you don't you'll get people down valuing your assessments because if "everyone else is doing it" it must be a good thing.
 
There have been a couple of "experiments" where monkeys, darts, or children have beaten professionally managed funds. That doesn't really say anything about capitalism it just says something about professional investors. Index funds tend to beat pretty much any managed fund.

I'd be incredibly sceptical about those. How were the professionally managed funds chosen? What were the criteria for beating? How many experiments were done where the monkeys/darts/children did not win and were therefore not published because the results weren't interesting?

The reason why I am sceptical is that my own funds in my pension and ISA seem to be doing better than random. They overall perform better than the FTSE 100 index for example.
 
The underlying assumption of a Rational Market is that all participants have the same goals and planning horizons.
It already fails if some participants have short-term and others long-term strategies.
 
Yes, capitalism is a very bad economic system. Because that is what a state run economy is, the ultimate expession of capitalism.

No. Capitalism is defined by private ownership running businesses for profit. State ownership would be the polar opposite


You want to disagree with reality, that's your prerogative. But then again this attitude is why classical economics is so divorced from reality.
For a theory that was superseded (not replaced) in the 1800's classical economics holds up pretty darn well. Classical economics and it's modern descendants work, which is why all mainstream economists subscribe to them.
 
Yes, capitalism is a very bad economic system. Because that is what a state run economy is, the ultimate expession of capitalism.
Interesting.

I'd be incredibly sceptical about those. How were the professionally managed funds chosen? What were the criteria for beating? How many experiments were done where the monkeys/darts/children did not win and were therefore not published because the results weren't interesting?

The reason why I am sceptical is that my own funds in my pension and ISA seem to be doing better than random. They overall perform better than the FTSE 100 index for example.
That's why I put "experiments" in "". They were mostly publicity stunts.
 
I'd be incredibly sceptical about those. How were the professionally managed funds chosen? What were the criteria for beating? How many experiments were done where the monkeys/darts/children did not win and were therefore not published because the results weren't interesting?

The reason why I am sceptical is that my own funds in my pension and ISA seem to be doing better than random. They overall perform better than the FTSE 100 index for example.

There is a considerable body of evidence that while a typical managed can beat the broader market, on average this is smaller than the fees they charge. For the average person the best strategy is not try and time the market and instead average into a low expense ratio fund that tracks the broader market.

As for monkeys throwing darts, I think that would depend on how the experiment was set up. Picking random company names is similar to tracking the broader market but not identical. Unless there is some weighting that accounts for company size they monkey would likely end up with a portfolio weighted towards smaller companies that may be more volatile and higher risk. Since higher risk investments demand a risk premium, a portfolio weighted towards smaller companies would likely outperform the market slightly, but at the cost of slightly higher risk.
 
There is a considerable body of evidence that while a typical managed can beat the broader market, on average this is smaller than the fees they charge. For the average person the best strategy is not try and time the market and instead average into a low expense ratio fund that tracks the broader market.

As for monkeys throwing darts, I think that would depend on how the experiment was set up. Picking random company names is similar to tracking the broader market but not identical. Unless there is some weighting that accounts for company size they monkey would likely end up with a portfolio weighted towards smaller companies that may be more volatile and higher risk. Since higher risk investments demand a risk premium, a portfolio weighted towards smaller companies would likely outperform the market slightly, but at the cost of slightly higher risk.
I think that's the bit I forgot to mention.
 
I'd be incredibly sceptical about those. How were the professionally managed funds chosen? What were the criteria for beating? How many experiments were done where the monkeys/darts/children did not win and were therefore not published because the results weren't interesting?

The reason why I am sceptical is that my own funds in my pension and ISA seem to be doing better than random. They overall perform better than the FTSE 100 index for example.

The Wall Street Journal used to have a six-month contest between the pros and stocks picked by using a dartboard. The contests ran for 14 years but overlapped, so there were a total of 142 battles. Overall the pros did better (about 10.2% average return) than the Dow (5.6%) and quite a bit better than the darts (3.5%).
 
I do appreciate this being spun off from the Musk/Twitter thread.

But I take issue with the title of this thread. I’m not sure anyone was arguing that markets are always “rational”, whatever that means, except in the trivial sense that reasons can always be concocted for why a stock or commodity is priced as it is.

The point I was making was that a stock or commodity is always priced exactly where it “should be”, all things considered. That renders any pontification about whether a stock or commodity is over- or under-priced as meaningless, except in retrospect. What might border on paradox is that “irrational” factors may be in play in determining that price. I might even argue that TA and astrology and “the madness of crowds” could be in play in determining the price.

Example(s) to follow…
 
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The point I was making was that a stock or commodity is always priced exactly where it “should be”, all things considered.
What are all the things that 'should be' considered?

That renders any pontification about whether a stock or commodity is over- or under-priced as meaningless, except in retrospect.
Not just meaningless, worthless. But in practice it is very useful information. it is also an essential part of market 'rationalism' because it tends to push the price towards an equilibrium or 'true' value.

What might border on paradox is that “irrational” factors may be in play in determining that price. I might even argue that TA and astrology and “the madness of crowds” could be in play in determining the price.
Not just maybe, in practice there are always irrational factors at play.
 
But seems to me that Government Ran Economies perform even worse.
The worst economies are those that have no government at all.

People point to to Russia as an example of state capitalism failing, but it wasn't the economy that failed. Fewer people point to China as an example because it didn't fail. Every 'successful' country has a mixed economy because unregulated markets fail regularly.

The great success of our modern economy is largely built on one thing - oil. But oil is destroying the environment. Without very strong action by governments, all that success is going to turn into an enormous failure that may take centuries to recover from (if ever). Numerous civilizations have been wiped by not managing resources properly, which takes more than just a blind 'invisible hand' guiding the market.
 
That and of course the good old "emperor's new clothes" syndrome - if other investors are heavily investing in a sector and you don't you'll get people down valuing your assessments because if "everyone else is doing it" it must be a good thing.

I think there's a bias for things perceived as new and high-tech.

Even with the housing bubble, although the underlying asset (housing) wasn't new, the financial instrument (collateralized debt obligations) was.

Also, the rating agencies that were supposed to do the "due diligence" on the CDOs fell down on the job.
 
I think someone who has the idea that markets could be rational has a huge uphill climb to prove they could be rational before even getting to make the claim they are rational. Markets are merely an expression of human behaviour, and we know 100% that human behaviour is not rational in general terms.

To look at it another way how do the constraints we impose on stock markets and the gambling that goes on ensure rationality?
 
All economic systems are perfectly rational, organized, and predictable until one of the following things happens:

- Someone gets greedy.
- Someone panics.
- Someone gets greedy because they are afraid other people are going to get greedy.
- Someone panics because they are afraid other people are going to panic.
- Someone gets greedy because they are afraid other people are going to panic.
- Someone panics because they are afraid other people are going to get greedy.

Luckily none of those things ever happens.
 
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What does ChatGPT have to say?

The concept of rationality in stock prices is a topic of debate among economists and financial experts. Some argue that stock prices reflect all available information and are therefore rational, while others argue that prices can be influenced by factors such as emotions, speculation, and market manipulation, which can lead to irrational movements in prices. Overall, it can be argued that stock prices are a combination of rational and irrational factors, but it's hard to make a definitive statement.
 
What does ChatGPT have to say?

The concept of rationality in stock prices is a topic of debate among economists and financial experts. Some argue that stock prices reflect all available information and are therefore rational, while others argue that prices can be influenced by factors such as emotions, speculation, and market manipulation, which can lead to irrational movements in prices. Overall, it can be argued that stock prices are a combination of rational and irrational factors, but it's hard to make a definitive statement.

Interestingly it says "are a combination of rational and irrational factors" therefore that means they are irrational - add irrationality into any rational system and it has to become irrational!
 
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