A test of the efficient markets hypothesis

by John Quiggin on August 29, 2004

Australian PM John Howard has called an election for 9 October. I’ve discussed the political issues here, but CT readers will also be interested in the implications for the efficient markets hypothesis. Centrebet , which didn’t do brilliantly last time, has the (conservative) Coalition at $1.55 and Labor at $2.30. If I’ve done my arithmetic properly, and allowing for the bookies’ margin, I get the implied probabilities as 0.60 for the Coalition and 0.40 for Labor. The polls have Labor ahead, but looking at all the discussion, I’d say that the consensus view is that the election is a 50-50 proposition, and that’s also my subjective probability.

How good a test of the efficient markets hypothesis will this be? Bayesian decision theory provides an answer[1]. If our initial belief is that the EMH is equally likely to be true or false, and the Coalition wins, we should revise our probability for the EMH up to 0.55. If Labor wins, we should revise it down to 0.45.

fn1. The workings are easy for those who know Bayes’ theorem and accept the modern subjectivist interpretation , but they won’t make much sense to those who don’t.

Load the flying bats

by John Holbo on August 29, 2004


After Flatworld, the sight of Oklahoma senator James Inhofe buckling on a virtual reality helmet at ICT headquarters seems positively old school. A technician shouts “Load the flying bats!” and the senator is transported to a damp tunnel near a farmhouse that may be an enemy hideout. Insects whir and water trickles in surround sound while digitized bats swoop and dive overhead. Inhofe is impressed. “It’s the closest thing to reality that I’ve ever experienced,” he says. “My feet felt wet.”

The senator is the institute’s most powerful advocate in Congress; he cosponsored the clause in the 2003 Defense Appropriations Act that gave ICT $7 million to build the Fort Sill installation. Last spring, the institute locked down another five-year contract with the Army.

A Republican who ran on a platform of “God, guns, and gays,” Inhofe revels in making statements that don’t play well in the liberal precincts of Blogistan. “I look wistfully back to the days of the Cold War,” he says, resting his cowboy boots on a chair after doffing his VR helmet. “Now someone very small can pose a greater threat than the Soviet Union.”

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