Matt Yglesias and Brad DeLong are both fond of this Economist quote: The [Efficient Capital Markets] hypothesis has two parts, [Thaler] says: the “no-free-lunch part and the price-is-right part, and if anything the first part has been strengthened as we have learned that some investment strategies are riskier than they look and it really is difficult to beat the market.” The idea that the market price is the right price, however, has been badly dented.
After the price for the bets are formed, it is possible to check the analysis of the model.
Prior to betting, to make money, you have to do a lot more than use the formula. You have to know what you are looking for at the tote board volume changes.
The "deep-pockets" isn't about acquiring the info, but about moving the market. Maybe small players have lots of info not in the market, and make money off of it, but if they don't move the market, they're not relevant to the price. So the price doesn't reflect that info (at least not very well), only the info available to big players.
People like to bridge the two worlds by saying that rational agents will become big players. But people have declining marginal utility with their own money and skewed preferences with other people's money.
Charles Davi of Derivative Dribble started off his blog with The Not So Efficient Market (Theorem) Hypothesis, which explores the distinction between two different meanings.
John Holbo has highlighted the EMH in his series of "refuted economic doctrines", which are now going to be made into a book "Dead Ideas From Live Economists".
David, just saying that's hardly widely available info.
(That's not why I wrote, though. Like I said, I read the number elsewhere without citation in which it was critical for an argument - so I was just interested in where that specific number is coming from.)
I had just read another blog citing 55% yesterday, hence my interest.
From what I can tell, that 55% DTI is only for non-conforming loans and was a back-end DTI. That would have been a tough piece of data to cull in the moment, and likely would have been very few loans.
tg, personal anecdote. When I was shopping around for a mortgage in late 2006 I was hearing that from mortgage brokers. Googling DTI 55% turns up old sites like this one:
There is an assymetry between long and short which helps drive bubbles. Going short exposes you to unlimited risk. Buying puts requires a bet not only on how wrong the price is but when it will be corrected. I made a little money on long term puts on a couple of homebuilders, but I would have done much better had my puts expired a year later than they did.
So I think you can know there's a bubble--I was certain of it for years before it popped--and yet be at a disadvantage when trying to profit from it. The only low-risk way to benefit is to not participate. Unfortunately, I couldn't even get that right. I bought a house in 2007.
You asked about widely available info. There was plenty. The rate of growth relative to historical averages and the growth of personal income, rental propery selling with negative cash flow, posh hotels being converted to condos, DTI limits increasing from 25% to 55%, etc.
In the very short timeframe (seconds and minutes), there are certainly price patterns in the stock market that allow for trading profits for experienced and talented traders who understand and can see the price / time patterns in the markets.
I suspect that other traders than myself are able to capitalize on medium and long term price movements, but I can personally demonstrate that EMH is wildly incorrect for very short timeframes (if by EMH it is meant that there are no ways of predicting the timing and direction of financial instrument price changes accurately enough to profit from them).
To people who overestimate (due to hindsight bias, etc) their ability to have made money, it is easy to mistake EMH claims as saying prices are wiser than EMH actually claims. So it might be better for explanations of EMH to put more emphasis on how much worse people have been at finding inefficiencies than they think they were or would have been.
Your reference to "deep-pocket market speculators" suggests that acquiring valuable info requires money. My experience indicates that money doesn't help much. The main costs are time (and probably loss of self-esteem) to learn to correct for overconfidence and to research a large number of potential inefficiencies (of which only a small number will turn out to be profitable).
There were lots of ways to bet against the bubble.
Shorting KB homes and Countrywide would have been a start. If there was a bubble those guys were sure to get nailed.
Also you could have totally moved everything into cash out of the market or just shorted the S&P knowing that housing had been a huge driver.
Big players could short MBS in a bunch of ways too, not just with the finacial contracts.
Also the "The market can stay irrational longer than you can stay solvent" issue is overdone. As long as you don't use leverage there is no reason that you can't ride your bet indefinitely. Just set aside cash for margin calls,
Maybe one of Taleb's methods for profiting from a black swan economic dive could be adapted for a burst bubble. The unpredictability of the timing of the burst seems a good match for the unpredictability of a black swan dive.
The best part is that Larry Summers quotes Google searches on "recession" as a sign the economy is getting back to normal. http://www.newsy.com/videos... As, Google holds the answer to our problems. Since people aren't searching "recession" as much, the economy must be getting back on track
During the tech boom I bought stock in a gold mining company because it seemed obvious to me that eventually the boom would end, people would get nervous, and gold would go up.
If I recall correctly it was around $1, and the company had suspended much of it's operations because the price of gold was too low to justify digging it out. But it had gold supplies on hand that were worth more than it current market cap, even at the low gold prices.
The boom kept booming, the share price went as low as $0.25, and I wished I had more money to invest. After the bubble popped, I think I sold at around $6.
I don't think it requires special insight to see that people are trading with their emotions, and it doesn't require perfect timing to just invest in things that aren't the things that are obviously going to crash.
Constant;
After the price for the bets are formed, it is possible to check the analysis of the model.
Prior to betting, to make money, you have to do a lot more than use the formula. You have to know what you are looking for at the tote board volume changes.
The "deep-pockets" isn't about acquiring the info, but about moving the market. Maybe small players have lots of info not in the market, and make money off of it, but if they don't move the market, they're not relevant to the price. So the price doesn't reflect that info (at least not very well), only the info available to big players.
People like to bridge the two worlds by saying that rational agents will become big players. But people have declining marginal utility with their own money and skewed preferences with other people's money.
Charles Davi of Derivative Dribble started off his blog with The Not So Efficient Market (Theorem) Hypothesis, which explores the distinction between two different meanings.
John Holbo has highlighted the EMH in his series of "refuted economic doctrines", which are now going to be made into a book "Dead Ideas From Live Economists".
I beleive it was common knowledge in 2006 to anyone who was paying attention. Certainly widely known enough for EMH to hold if EMH holds at all.
David, just saying that's hardly widely available info.
(That's not why I wrote, though. Like I said, I read the number elsewhere without citation in which it was critical for an argument - so I was just interested in where that specific number is coming from.)
tg, so what?
David,
I had just read another blog citing 55% yesterday, hence my interest.
From what I can tell, that 55% DTI is only for non-conforming loans and was a back-end DTI. That would have been a tough piece of data to cull in the moment, and likely would have been very few loans.
tg, personal anecdote. When I was shopping around for a mortgage in late 2006 I was hearing that from mortgage brokers. Googling DTI 55% turns up old sites like this one:
http://www.mortgagegrapevin...
David,
Could you corroborate the 55% DTI limit. Where did you get that?
There is an assymetry between long and short which helps drive bubbles. Going short exposes you to unlimited risk. Buying puts requires a bet not only on how wrong the price is but when it will be corrected. I made a little money on long term puts on a couple of homebuilders, but I would have done much better had my puts expired a year later than they did.
So I think you can know there's a bubble--I was certain of it for years before it popped--and yet be at a disadvantage when trying to profit from it. The only low-risk way to benefit is to not participate. Unfortunately, I couldn't even get that right. I bought a house in 2007.
You asked about widely available info. There was plenty. The rate of growth relative to historical averages and the growth of personal income, rental propery selling with negative cash flow, posh hotels being converted to condos, DTI limits increasing from 25% to 55%, etc.
In the very short timeframe (seconds and minutes), there are certainly price patterns in the stock market that allow for trading profits for experienced and talented traders who understand and can see the price / time patterns in the markets.
I suspect that other traders than myself are able to capitalize on medium and long term price movements, but I can personally demonstrate that EMH is wildly incorrect for very short timeframes (if by EMH it is meant that there are no ways of predicting the timing and direction of financial instrument price changes accurately enough to profit from them).
To people who overestimate (due to hindsight bias, etc) their ability to have made money, it is easy to mistake EMH claims as saying prices are wiser than EMH actually claims. So it might be better for explanations of EMH to put more emphasis on how much worse people have been at finding inefficiencies than they think they were or would have been.
Your reference to "deep-pocket market speculators" suggests that acquiring valuable info requires money. My experience indicates that money doesn't help much. The main costs are time (and probably loss of self-esteem) to learn to correct for overconfidence and to research a large number of potential inefficiencies (of which only a small number will turn out to be profitable).
There were lots of ways to bet against the bubble.
Shorting KB homes and Countrywide would have been a start. If there was a bubble those guys were sure to get nailed.
Also you could have totally moved everything into cash out of the market or just shorted the S&P knowing that housing had been a huge driver.
Big players could short MBS in a bunch of ways too, not just with the finacial contracts.
Also the "The market can stay irrational longer than you can stay solvent" issue is overdone. As long as you don't use leverage there is no reason that you can't ride your bet indefinitely. Just set aside cash for margin calls,
Maybe one of Taleb's methods for profiting from a black swan economic dive could be adapted for a burst bubble. The unpredictability of the timing of the burst seems a good match for the unpredictability of a black swan dive.
The best part is that Larry Summers quotes Google searches on "recession" as a sign the economy is getting back to normal. http://www.newsy.com/videos... As, Google holds the answer to our problems. Since people aren't searching "recession" as much, the economy must be getting back on track
During the tech boom I bought stock in a gold mining company because it seemed obvious to me that eventually the boom would end, people would get nervous, and gold would go up.
If I recall correctly it was around $1, and the company had suspended much of it's operations because the price of gold was too low to justify digging it out. But it had gold supplies on hand that were worth more than it current market cap, even at the low gold prices.
The boom kept booming, the share price went as low as $0.25, and I wished I had more money to invest. After the bubble popped, I think I sold at around $6.
I don't think it requires special insight to see that people are trading with their emotions, and it doesn't require perfect timing to just invest in things that aren't the things that are obviously going to crash.