{"id":3507,"date":"2009-08-26T13:45:18","date_gmt":"2009-08-26T18:45:18","guid":{"rendered":"http:\/\/countingpips.com\/fx\/?p=3507"},"modified":"2009-08-26T13:45:18","modified_gmt":"2009-08-26T18:45:18","slug":"efficient-market-hypothesis-true-villain-of-the-financial-crisis","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/fx\/2009\/08\/26\/efficient-market-hypothesis-true-villain-of-the-financial-crisis\/","title":{"rendered":"Efficient Market Hypothesis: True “Villain” of the Financial Crisis?"},"content":{"rendered":"

By Robert Folsom<\/strong><\/p>\n

Editor’s Note: The following article discusses Robert Prechter’s view of the Efficient Market Hypothesis. \t\t\t\t\tFor more information, download this free 10-page issue of Prechter’s Elliott \t\t\t\t\tWave Theorist<\/a><\/strong>.<\/p>\n

When a maverick idea becomes vindicated, there’s a good story to tell. It usually involves a person (or small group of \t\t\t\t\tpeople) who courageously challenge the orthodoxy of the day — and, over time, the unorthodox yet better idea prevails.<\/p>\n

A “good story” of this sort has surfaced during the current financial crisis. A chapter of the story appeared \t\t\t\t\tin a recent New York Times article, “Poking Holes in a Theory on Markets.” The theory in question is the efficient \t\t\t\t\tmarket hypothesis (EMH), which the article suggested is so hazardous that it “is more or less responsible for the \t\t\t\t\tfinancial crisis.” This quote tells you most of what you need to know:<\/p>\n

“In the last decade, the efficient market hypothesis, which had been near dogma since the early 1970s, has taken \t\t\t\t\tsome serious body blows. First came the rise of the behavioral economists, like Richard H. Thaler at the University of \t\t\t\t\tChicago and Robert J. Shiller at Yale, who convincingly showed that mass psychology, herd behavior and the like can have \t\t\t\t\tan enormous effect on stock prices \u2014 meaning that perhaps the market isn’t quite so efficient after all. \t\t\t\t\tThen came a bit more tangible proof: the dot-com bubble, quickly followed by the housing bubble. Quod \t\t\t\t\terat demonstrandum.” <\/em><\/p><\/blockquote>\n

In case your Latin is rusty, Quod erat demonstrandum<\/em> means “which was to be demonstrated.” Its abbreviation \t\t\t\t\t(QED) appears at the conclusion of a mathematical proof. In this case, the massive financial bubbles of recent years are \t\t\t\t\tthe proof that refutes the efficient market hypothesis, which argues that markets move in a “random walk” and \t\t\t\t\tare not patterned.<\/p>\n

Similar articles in the financial press have reported the demise of the EMH. Just this week an Economist magazine blog \t\t\t\t\tincluded this bold declaration:<\/p>\n

“No one has yet produced a version of the EMH which can be tested and fits the evidence. Thus, the EMH must logically \t\t\t\t\tbe discarded, as a valid hypothesis must be testable.” <\/em><\/p>\n

QED, indeed — I agreed years ago that the random walk was implausible. But I didn’t come to this view because of behavioral \t\t\t\t\teconomists, although their work over the past decade has certainly been valuable. Instead, I was persuaded by the work \t\t\t\t\tof someone who first challenged the financial orthodoxy more than three decades ago, specifically April 1977<\/strong>. \t\t\t\t\tAs a young technical analyst at Merrill Lynch in New York, his research circulated among several of Merrill’s clients. \t\t\t\t\tHis name for these studies was the Elliott Wave Theorist<\/em>: the April ’77 study was a detailed analysis of the 1975-76 stock \t\t\t\t\tmarket, which offered this comment on the random walk model:<\/p>\n

“If market moves are arbitrary (as the random walk proponents suggest), then internal components would rarely \t\t\t\t\t‘make sense’ mathematically, and then only by statistically insignificant fluke occurrences. However, there \t\t\t\t\tseems to be enough evidence that mass psychology, as recorded in the Dow Jones Industrials, form patterns \t\t\t\t\tthat are uncannily interrelated….At least this much can be fairly reliably stated as a result of this work: This \t\t\t\t\tidea that the market is a ‘random walk’ is probably false.” <\/em><\/p><\/blockquote>\n

Robert Prechter left Merrill soon after; he has published the Elliott Wave Theorist<\/em> in every month since. Every issue \t\t\t\t\thas, in one way or another, “convincingly showed that mass psychology, herd behavior and the like can have an enormous \t\t\t\t\teffect on stock prices.”<\/p>\n

So while there may be a good story to tell about behavioral economists, I trust you see why I believe there is a vastly \t\t\t\t\tbetter one to tell.<\/p>\n

The “enormous effect” of “mass psychology” and “herd behavior” is exactly what explains \t\t\t\t\tthe financial downturn that began in late 2007. Prechter’s Elliott Wave Theorist<\/em> anticipated the crisis and warned subscribers \t\t\t\t\tbeforehand. Likewise, he alerted them to the bear market rally that began last March.<\/p>\n

For more information from Robert Prechter, download a FREE 10-page issue of The \t\t\t\t\tElliott Wave Theorist<\/em><\/a><\/strong>.<\/em> It challenges current recovery hype with hard facts, independent analysis, and insightful \t\t\t\t\tcharts. You’ll find out why the worst is NOT over and what you can do to safeguard your financial future.<\/p>\n

Robert Folsom<\/em><\/strong> is a financial writer and editor for Elliott \t\t\t\t\tWave International. He has covered politics, popular culture, economics and the financial markets \t\t\t\t\tfor two decades, via print, radio and the Internet. Robert earned his degree in political science \t\t\t\t\tfrom Columbia University in 1985.<\/em><\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

By Robert Folsom – When a maverick idea becomes vindicated, there’s a good story to tell. It usually involves a person (or small group of people) who…<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-3507","post","type-post","status-publish","format-standard","hentry"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts\/3507","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/comments?post=3507"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts\/3507\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/media?parent=3507"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/categories?post=3507"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/tags?post=3507"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}