"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Thursday, February 4, 2010

Answer to Scott Sumner

Scott Sumner discusses the EMH:
The commenter 123 sent me a link to an article by Andrei Shleifer, which argues that markets aren’t efficient.
You have to be impressed by the resourcefulness of the anti-EMH, crowd. If LTCM and its merry band of Nobel-Prize winning economists had actually beat the market, if they had used market anomalies to get rich, well then it would have been the death knell of the EMH. Every time Fama said “if you’re so smart how come you’re not rich,” people would have responded that Scholes and Merton did get rich by spotting market inefficiencies. Instead they failed miserably, and this shows . . . it show that markets are inefficient because the market can stay irrational longer than you can stay solvent.
OK everyone, tell me where I’m wrong. What outcome of LTCM’s bet on Shell Oil would have supported the EMH?
It is very simple. If LTCM's bet on Shell was successful, the market would be less inefficient than before that bet, and EMH would be a little bit less wrong than before. As we know LTCM had to liquidate Shell Oil arbitrage position, and their attempt to improve the efficiency of markets was unsuccesful. There is no paradox at all - any outcome of LTCM's bet on Shell Oil would have supported neither EMH nor the theory of phlogiston.

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