Yglesias dings the efficient market hypothesis based on a conversation with German bankers

Basically they were saying we should blame the clients. “We give the customer what he asks for” they say, and (someone sarcastically) maybe “more regulation is needed on the investor side” rather than on the bankers. They say that after the crisis hit, people got very conservative but already “clients are coming back and asking for emerging market bonds and hedge funds. Banking is a customer service industry that like any customer service industry is grounded in human nature and “human nature is driven by greed and fear.”

This is plausible stuff I think. But it’s also strikingly far afield from the Efficient Markets Hypothesis . . .

I’ve been rethinking my already somewhat heterodox position on the Efficient Market Hypothesis (EMH) recently but Yglesias is going to far.

The EMH doesn’t suggest that no traders are driven by emotion or really dumb ideas. In its strongest form it only says that being dumb won’t hurt you. Being smart won’t help you either of course, market prices always reflect the best information available.

Maybe you don’t think that’s true. I certainly don’t. But you might believe a weaker version which says that one can’t systematically do better than average. The way I have tended to view that constraint is to say, any understanding of the market or sense of timing that makes money over the long haul cannot be written down and explained. In the modern world it probably can’t even be written into a computer program.

It might, however, be tied up in the cognitive make-up of some individual. That is, maybe Buffet really can pick ‘em but that doesn’t mean you can learn to be like Buffet. His ability is wound up in his biology.

Recently, I’ve been backing away from even that. Nonetheless, none of these hypotheses rules out idiotic behavior.


I should also add that they don’t rule out mass hysteria either. There is no way to pin down what risk aversion “should be.” Suppose that everyone suddenly got more scared. They really became risk averse. Then a perfectly efficient market would necessarily fall.

Nor I would argue is there anything irrational about random fear. Despite people falling for the myth of autonomy, you are scared because of a series of autonomic reactions that may or may not be related to some true threat. Sometimes there is a threat and it can be pinpointed. Sometimes there is not a threat but people rationalize one into existence.  But, at no time is your being scared dependent on there being a true threat.