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efficient markets

Fortunately I didn’t contract with Chris in advance to contribute to the Graeber seminar, so I’m not in debt on this score, paying late and therefore a bad person.

Right. I’m only about halfway through the book – on audiobook: must have something to do on the bus – and quite enjoying it. Some skepticism about Graeber’s scholarship has been expressed in the wake of revelation of that embarrassing bit about Apple computers that he got totally wrong. I am not an expert on all the ancient and exotic anthropological and etc. evidence Graeber cites, but I’m not an absolute beginner. I started studying the history of ideas of debt, and related subjects, a few years back. See here and here. I started because it occurred to me the Plato I was teaching was, to a surprising extent, about debt, reciprocity and, generally, the convertability of moral into monetary categories, and vice versa. Euthyphro on piety. It’s ‘care of the gods’, which – this is his final suggestion – turns out to be the capacity to enter into healthy exchange relations. Meno on whether being good boils down to getting your hands on the goods. Cephalus, the old man, launches the mighty ship, Republic, with the thought that justice is ‘speaking truth and paying debts’, which morphs into the lex talionis thought that justice is payback – doing good to friends and harm to enemies. Plato, like Graeber, is really really concerned to shred this stuff, if he can. So I find Graeber interesting. I haven’t gotten to the bits where Graeber discusses Plato, but I see he does discuss him. And I haven’t found any flagrant inconsistencies between what he says about other ancient stuff and what I have read in other authors about ancient stuff. So I’m inclined to think the Apple slip was a one-off accident, not indicative of larger problems. As to the tribute system stuff. It sounds like Henry is right about that and Graeber is wrong. I haven’t gotten to that part of the book yet.

Right. Getting down to business. Here’s what seems to me a fundamental tension in the book. On the one hand, Graeber wants to emphasize that debt is a very specific relation. Everything isn’t debt, human relations-wise. More generally, everything isn’t exchange. For him, this is the larger significance of defeating the myth of barter and the double-coincidence and all that (go read the other posts if you don’t know what I’m talking about.) Money emerges as a way of accounting for debt, but not everything is debt. So money isn’t a way of accounting for everything. I’m simplifying, but this is the gist. (One of many gists, but enough for one post.) [click to continue…]

Discussion on my last post on reanimated zombie ideas in economics touched on a lot of the themes I want to talk about in this one, about the efficient markets hypothesis and why this undead monster can never be laid to rest. (Warning: favorable references to Popper ahead!).

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A bit more from my book-in-progress. I’m currently toying with the title Zombie Economics: Seven Economic Ideas that Aren’t Dead but Should Be. As always, I’m keen to get suggestions on this, and on improvements to the text. I’m particularly happy to have putative errors pointed out. If I agree with you about the error that saves me from putting it in print. If not, it will be a point I need to anticipate and respond to.

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This is the first in what I hope will be an extensive series of extracts from my forthcoming bestseller Dead Ideas from Live Economists 1. I’m inviting comments and suggestions from readers, with free copies of the book for the ten best. To avoid cluttering the home page, the substance will be over the fold, with only a short intro like this for each post.

Update The discussion has been very helpful, though a lot has more to do with what will come later. In this section, I’ve changed the para about Keynes speculative career a little.
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Over at my blog, I’ve started a series of posts on economic doctrines and policy proposals that have been refuted or rendered obsolete by the financial crisis. There will be a bit of repetition of material I’ve already posted and I’ll probably edit the posts in response to points raised in discussion. I’m crossposting here in the hope of getting more discussion, but readers who aren’t interested in econowonk stuff may want to skip this series.

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A test of the efficient markets hypothesis

by John Q 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.

Reading the discussion of earlier posts about the efficient markets hypothesis, it seems that the significance of the issue is still under-appreciated. In this post, Daniel pointed out the importance of EMH as a source of pressure on less-developed countries to liberalise capital flows, which contributed to a series of crises from the mid-1990s onwards, with huge human costs. This is also an issue for developed countries, as I’ll observe, though the consequences are nowhere near as severe. The discussion also raised the California energy farce, which, as I’ll argue is also largely attributable to excessive faith in EMH. Finally, and coming a bit closer to the stock market, I’ll look at the equity premium puzzle and its implications for the mixed economy.

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Efficient markets (addendum)

by Daniel on July 22, 2004

This is more of a footnote to John’s post on the subject than a substantive contribution, but it struck me that, despite John having made the point otherwise, the debate in comments (here and on Asymmetrical Information still seemed to be based on a few commonly held fallacies about the efficient markets theory;

  • that it is basically a neutral, academic theory with few implications for the real world
  • that it is basically all about the stock market (to be honest, most of the discussion revolved around the US stock market)
  • and that, to quote James Surowiecki, “whether or not markets are perfectly efficient, they’re better than any other capital allocation method that you can think of.

None of these are true.

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Hows about them efficient prediction markets?

by Henry Farrell on March 12, 2006

I “mentioned”: a few days ago that Paddy Power had opened a book on the race to succeed Bill Emmott as editor of the _Economist_, and suggested that depending on liquidity, there was a fair amount of scope for manipulating the results. I’m sorry to report that my speculations were “bang on the mark”:,,8210-2076421,00.html.

bq. Paddy Power, the bookmaker, has been offering odds on the new editor, to replace the departing Bill Emmott. Several punters this week started to put large sums ranging up to £500 on Ed Carr, the business and financial editor, at 6-1. The bookie yesterday suspended all bets, after even more tried to open accounts. Any of them e-mails with “theeconomist” somewhere in the address? “We haven’t seen anything quite that unsubtle. They’re more intelligent at The Economist. Mind you, when we ran a book on the editor of The [Daily] Mirror . . .”

The Economist‘s journalists have always been quite keen on the “predictive”: “power”: of betting markets. Nice to see a few of them put their money where their mouth is. In other news on the race for the prize, I hear that “Clive Crook”: is now a hot contender, and “Chris Anderson”: is climbing up that long tail. Not that you’re able to bet on either of them now, but still.

I have a piece in the New York Times looking at the implications for the bitcoin bubble for economic theory and, in particular, for the (Strong) Efficient (Financial) Markets Hypothesis (EMH) which states that prices determined in financial markets reflect all the available information about the value of any asset. If that’s true then governments can’t improve on a policy of allocating investment to those assets with the highest market return, which can be achieved by letting private capital markets determine all investment decisions.

Bitcoins have no inherent usefulness, being a record of pointless calculations. They are useless as a currency (their putative purpose) and are now being promoted as a store of value on the basis of scarcity alone. This leaves supporters of the EMH with a dilemma.

If Bitcoins are indeed worthless, then financial markets should price them at zero. But the introduction of futures trading actually boosted the price in the short run. Even after recent declines, there’s no sign that prices will reach zero any time soon.

On the other hand, if Bitcoins are valuable simply because people value them, then asset prices are entirely arbitrary. The same argument can be applied to any financial asset.

Dean Baker at CEPR has a nice followup, making the obvious but crucial point that, since financial services are an intermediate input to production, we want the financial sector to be as small as possible, consistent with doing its essential tasks. As the experience of the mid-20th century shows, a market economy can function perfectly well with a financial sector much smaller than the one we have today. As Bitcoin shows, the massive expansion since then is nothing but wasteful speculation. The financial sector should be cut down to (a small fraction of its present) size.
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Markets and Freedom: Common Mistakes

by Henry Farrell on July 6, 2012

“Matthew Yglesias has a post responding”: to my post below. My original intention was to roll it into an update – I then decided it was worth responding to on its own because it exemplifies a number of common mistakes in thinking about markets. In order:

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Free markets and insurance

by Henry Farrell on July 27, 2009

I’m not writing about the debates over health insurance (as, indeed, I am not writing about most policy debates), because I simply don’t think I’m informed enough to say anything very useful about the pros and cons of the specific options under discussion. Still, “this”: by Alex Tabarrok struck me as a bit odd. [click to continue…]

More on the Iowa Electronic Markets

by Daniel on September 8, 2004

Here’s bit of bad news for my American Democrat friends; your candidate is dying on his arse in the Iowa Electronic Markets at the moment.

Here’s another bit of bad news; even at these prices, he’s still overvalued.

Note to readers. There is quite a lot of financial jargon in this post, because I’m dealing with quite a few issues that are only of interest to finance bods (and only marginally to them). The interesting stuff is toward the end.

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Markets, Firms and Planning

by Kieran Healy on July 23, 2004

Some threads of the “ongoing”: “discussion”: about the Efficient Markets Hypothesis have begun to address the contrast between markets and planning, with the state as the prospective planner. As is often the case in such discussions, the implicit contrast is between a Hayekian information-processing ideal and, say, North Korea. To break down this assumption a bit, it’s worth drawing a link to a related debate in the economics and sociology of organizations about the existence of the firm. A long time ago, “Ronald Coase”: asked why, if markets are so great, are there so many firms? Below the fold is an “old post of mine”: where I examine “Brink Lindsey’s”: efforts to defend the virtues of free markets in the light of Coase’s ideas. It might be of interest as a sidelight to the EMH debate.

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Election Markets

by Brian on February 5, 2004

As Daniel noted a while back on CT, the election markets that have opened so far aren’t efficient enough to prevent arbitrage opportunities. This point now seems to have been noticed by more mainstream commentators.

But whatever the reason, there is a significant pricing difference between these two markets [Tradesports and the IEM] — an arbitrage opportunity that you’d expect some savvy trader to take advantage of. Yes, the contracts are constructed a bit differently, but surely there’s a way to go long Bush on Iowa, short him on Tradesports, and make some surefire coin.

The pinko Money magazine attributes the inefficiency to sheer irrationality on the part of the traders in each market. If that’s right then the added evidential value of these markets is roughly the same as star charts.