Finance Profs Won’t Bet

Feel tempted to play the markets?  How much more tempted would you be if you were a professor of finance, certified as an expert whose main job was to study such markets?  Turns out, most finance profs know enough to know they don’t know enough to bet:

Employing a survey distributed to over 4,000 [finance] professors, we obtain four main results. First, most professors believe the market is weak to semi-strong efficient. Second, twice as many professors passively invest than actively invest. Third, our respondents’ perceptions regarding market efficiency are almost entirely unrelated to their trading behavior. Fourth, the investment objectives of professors are, instead, largely driven by the same behavioral factor as for amateur investors – one’s confidence in his own abilities to beat the market, independent of his opinion of market efficiency.

If finance profs are this reluctant to disagree with market prices, perhaps you should be even more reluctant to disagree, and just take that index fund?

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  • Sergei

    Playing the markets well enough to beat them requires a significant time commitment researching minutia. I doubt finance profs have that time, and for them index funds are fine, but many others do.

  • kebko

    I just don’t understand this exceptionalism about financial markets.

    I can go to the supermarket & assume that the T-Bone steaks are of a certain quality. In that situation, I am like a passive investor. There are lots of decisions to make about how much red meat to have in my diet, how high the price of steak is relative to other foods, etc. But, I more or less assume that the T-Bone in front of me is a reasonable representation of the market in meat, and that the cut was meant to be a T-Bone. In other words, it’s a semi-efficient market.

    But, for that cut of meat to get there, there were many people involved. People that know how to cut a carcass, people that know what qualities in a bull will sire calves that make good T-Bones, etc. These are like the target investors.

    I have no idea how to create good T-Bones. In that market, I am a passive investor. I am an active investor in stocks, however. Your position seems to be that since you don’t know how to create a good T-Bone, then nobody can, and if somebody thinks they can create a good T-Bone, they must be deluded.

    Finance profs may be able to tell you how much red meat to have in your diet, or if steak is a good buy right now, but that doesn’t mean they know how to breed cattle. So, there is no contradiction for them to believe in semi-efficient markets while thinking they might have the skill to take advantage of mis-pricings (or vice versa). The two opinions are unrelated.

    The markets are up 50% since March & many equities are up well over 100%. It took skill to be buying then, and that skill probably doesn’t correlate that well with the skills you need to be a Finance prof. Charlie Munger doesn’t talk about multi-optimization models; he talks about human psychology. So, this is a Hayekian situation where the people who do have the skill to outguess the market probably can’t even quantify or describe exactly what that skill is.

    It is true that most people should be passive, but without active investors earning returns on their skill in choosing investments, the market would be no more efficient than the T-Bone market would be without Angus breeders.

    • Sean C.

      Best summed up by Chris Farley in Tommy Boy

      I can get a good look at a T-bone by sticking my head up a bull’s ass, but I’d rather take a butcher’s word for it.

    • Mike

      The markets are up 50% since March & many equities are up well over 100%. It took skill to be buying then

      You think so? I’m a layman and I thought it was obvious to buy in — and I did — the only reason I didn’t throw in more was because most of my money was already there.

      I’ve been surprised through all this that more people didn’t do the same. Granted, back in March, it was not at all obvious that such huge gains would be made by now. But I think it was reasonably probable that, at some point over the next several years, they would. Meanwhile I thought it was very unlikely that, over that same period, stocks would fall dramatically and stay low. So my only understanding of the situation is that most of the people with lots of money at play simply don’t have the patience to wait several years.

  • peatey

    In other words, professors of CAPM believe what they teach?
    If pastors believe what they preach, then their appeal to authority has credence?

  • Josh Prowse

    And maybe the professors who do think that you can beat the market have left the academy to join hedge funds. Selection bias?

  • Luis Enrique

    active investment – by which I mean buying and selling shares in accordance with a perceived gap between prices and fundamentals – generates a massive externality, via capital allocation decisions in the real economy. If the economy makes good capital allocation decisions, the value of the index which you think we should all track, will be higher.

    I know it’s not individually rational to pay for the service for which you only capture a fraction of the benefits, but it does amaze me how the economics profession is happy to chorus “buy index funds” and say nothing (little) about the importance of somebody in the market keeping capital prices tied as closely as possible to the real productivity of capital assets. In other settings, economists can talk at great lengths about the importance of capital allocation decisions (indeed misallocation is one of the leading candidates to explain observed differences in TFP between countries – see Haltiwanger’s work for references).

    Why don’t economists worry more about the information externality generated by active investment, and the under-supply of information that would result from everybody just buying index funds?

    • gwern

      Most people are just noise traders, or worse, fools. No matter how much the professors tell them to just buy indexes, there will always be many who ignore them. But you can at least try to help those who will listen. Leave the markets to the financial sector.

      Worrying about the market becoming inefficient because of the statistical research is like worrying about those poor tobacco companies once the tobacco-death link has been proven. (On a side note, global tobacco use is apparently increasing.)

  • Seems like a good moment to mention that experiment where they found active traders in the US did worse than passive ones, even before considering transaction costs. Active traders reliably bought high and sold low. I’ll find the reference when I get home.

    • Joe Teicher

      This is evidence against efficiency. If markets are efficient then it shouldn’t be any more possible to buy high and sell low as it is to buy low and sell high. If markets are efficient everyone should do about the same on average (adjusting for risk).

  • q

    what would imply that the market for finance profs is efficient and complete? if some weak conditions hold on this market then one could imagine choosing an instructor who is a kind of “index fund” of finance profs.

  • kebko, I didn’t say no one should ever speculate.

    Luis, yes there are info externalities from pricing assets well.

  • Mike

    My wife works at Sloan School and many of the finance profs she works for manage hedge funds on the side.

    However there is a big difference between how you manage someone else’s money, and how you manage your own. I guess the poll is careful to make the distinction.

    • Sure finance profs are willing to bet other people’s money.

      • gwern

        But isn’t most compensation in hedge firms locked up in the company, with long periods until withdrawal? That gives them at least a small stake in the hedge fund.

  • Pat

    The abstract doesn’t make sense to me.

    “First, most professors believe the market is weak to semi-strong efficient. Second, twice as many professors passively invest than actively invest. Third, our respondents’ perceptions regarding market efficiency are almost entirely unrelated to their trading behavior.”

    If a most professors (who spend their time teaching and writing papers instead of researching individual companies) who believe the market is weak or semi-strong efficient passively invest, it seems like their trading behavior is entirely related to their perceptions regarding market efficiency.

    • John

      I believe they just mean they ran a regression trying to predict each person’s trading behavior based on their perceptions of market efficiency, and found that their respondents are no more (or only slightly more) likely to actively invest if they believe markets are less efficient. They’re not saying “it doesn’t make sense that this group would passively invest while believing in weak or semi-strong EFT,” they’re saying “beliefs in EFT were not a powerful predictor of investment behavior for individuals within this group.”

  • Robert Koslover

    I think Robin’s observation demonstrates that finance is a poorly understood subject. Compare: People come to me to advise them in selection, use, and design of microwave antennas, as well as for detailed analyses of antenna performance and predictions thereof. If my analyses and predictions were wrong too often, I would be out of work. But financial profs and advisors somehow stay in business. I figure that In an even moderately-free market, the only way this situation can persist is that there must be a severe shortage (to put it mildly!) of people who actually understand financial matters well enough to be able to make accurate predictions. Am I wrong? Well, I can name numerous other antenna experts that I would trust to design an antenna, without me looking over their shoulders. How many financial experts would you truly trust to invest your money, without you looking over theirs?

    • Would you trust them to design an antenna without oversight if the cost of the design was most of your net worth? And if they would have no way to give the money back if they failed?

      • Robert Koslover

        Yes, there are some I would trust to do that. Not many, but definitely some.

  • illuminatus?

    The fallacy of the argument against the EFM theory and the argument for index funds is that all studies as regards to active management has been done on highly regulated, very efficient and very transparent markets and on large indicies such as S & P 500 etc.

    I have worked as a fund selector and designer of fund supermarkets for 20 years. My sections outperform the market after fees almost all the time, between 75-90 %.

    The reason is that I started investigating Frontier Technology and Frontier Markets and to my surprise found the mainstream academic theory did not apply i.e. fund and manager selection does not add return. I found that the more opaque, inefficient and less regulated the special sector was the more premium was put on active selection by managers.

    This led me to the conclusion that the portion of your portfolio that is invested in large indicies should be indexed, not even that in fact ultra passive. But the rest of your portfolio should be invested in ultra aggressive funds. For a typical US investor that means between 30-50 % of the portfolio.

    Addendum: My personal 401 K has an annualized rate of return from 2001 to today of over 10 %. My stock and fund port folio is up 248 % since bottom and up 42 % since the market crashed.

    I have let the most important issue Asset Allocation and Tactical Asset Allocation slide, 75-90 % of your return comes from it. .

  • Bill

    I would be intersted in knowing how a behavioural economist selects his portfolio, and how he reallocates it.

    I would assume persons believing in the EMH would be passive. But, what about a behaviouralist? Would they be momentum or countercyclical investors?

  • Nothing beats being lucky. I would rather be lucky than good. Being a small fish in a big pond helps too.

  • Matthew C.

    Next week, I’m closing out a year on sim account daytrading S&P futures.

    +560%. It would be a lot higher but the maximum size the sim will allow me to trade (default size, which I need to use for execution speed) is 10 contracts. I have not had an unprofitable day (after commissions) for 3 months. In the next month or so I will start trading live.

    There’s your “efficient market” for you. . .

    However I will admit it is far easier to see and learn the daytrading patterns than the longer term patterns (since with daytrading you can see hundreds of pattern reps in a year instead of a handful or a couple dozen of pattern reps). Also the S&P futures market is highly utilized by large players who make lots of easy-to-read “dinosaur footprints” as they move into and out of positions. So you can see them and frontrun them. I did not have the same amount of success daytrading equities.

    BTW the main reason the market is up so much is fear / belief that the Fed is destroying the dollar through QE. . . If that belief changes then the current equities bubble will collapse again, since the macro / fundamentals right now are absolutely horrific. . .

  • Dave Hedengren

    My Vanguard account and I feel so validated.

  • Paul J

    2 things:

    1. As said many times before, once people start believing the EMH is true, it will stop being true. The only reason EMH exists is because people don’t believe it. (hopefully, i said it correctly, i’m working on very little sleep)

    2. To Matthew and illuminatus. I am sure I can find 2 people who have lost equal amounts in the past year (or whatever your timelines are). If your 2 examples disprove the EMH, then my 2 would prove it again.

  • Paul J

    Also, to Matthew,

    QE means nothing if you are paying interest on reserves. But that debate is probably far too off topic to have here.

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  • Matthew C.


    I am daytrading the emini S&P 500 contract many times per day, and haven’t had a losing day in 3 months. According to EMH theory I am just supremely lucky (let’s say I only traded 60 days out of the past 90 due to vacation and holidays and weekends, and the average trading win/loss percentage over a day is a coin flip — that would make my performance possible by chance at 1 in 2^60, or 1 in 1,152,921,504,606,846,976). I don’t think so. . .

    • ted

      I’m confused, you’re just fake trading. You’re not actually *up* any money. What are you bragging about?

    • Paul J


      That’s not the correct probablity to look for. Since you are trying to argue that since you (1 person) has had 60 straight days of gains, the EMH is flawed; you need to find the chance that at least 1 person would have had such luck since the stock market was created. I don’t feel like doing the math, but the odds are a ton higher than 1 in 2^60.

      I fake traded also and out of 60 days probably had 40 gains. The probablity of my exact results happening (gaining the days i gained and losing the same days i lost) is 1 in 2^60 also, but that doesn’t really mean anything

  • anon

    All, according to the EMH theory, daytraders are mostly compensated for providing liquidity. Most daytraders use simple strategies based on market microstructure; they don’t try to improve on the market’s evaluation of fundamental values.

    • Paul J


      Not saying I don’t believe you, I just have never heard of what you claim (I haven’t done a lot of research on it). Do you know of any online articles or papers that explain this, google has failed me.

  • Dan Egan

    I’m sorry – but did you miss the second half of the paragraph?

    Third, our respondents’ perceptions regarding market efficiency are almost entirely unrelated to their trading behavior. Fourth, the investment objectives of professors are, instead, largely driven by the same behavioral factor as for amateur investors – one’s confidence in his own abilities to beat the market, independent of his opinion of market efficiency.

    Finance professors might say they believe in EMH, but their behaviour says otherwise. They seem to believe that “The market is efficient for everyone except me.”

    Put conversely, all the active traders, hedge fund managers, prop desk traders etc might agree as much as finance profs that “markets are efficient”, but that doesn’t stop them from going to work in the morning.