The Efficient Market Hypothesis Revisited
There was once an old dude, Eugene Fama, who wanted to be immortal but knew he couldnt fly or go on a shooting rampage . So instead he came up with an awesomely out of this world theory. He asserted that the human beings were rational creatures and that we always make the most informed decision.
Unlike Newton, he couldnt name his theory after himself, since Fama's Law sounds so...errgggh. So he called it the Efficient Market Hypothesis. The financial world was in over itself cuz they finally had a law - and everyone knew a field is not really important unless it had a law or two. Now they can all act high and mighty in a I-have-a-law-nae-nae-nae-nae-nae kind of way.
I'm no economist, but what this theory basically says is the financial market (hence people) is omniscience (talk about being egoistical). Every information out there is already reflected in the prices of the assets. So for example, if you found out that company A was going to earn a huge profit, and you wanna buy its stock so you can cash in on its profit, DREAM ON! You are not gonna earn a profit because everybody else also know what you know, so they also rushing to buy the stock and driving up the price.
But cowmon! Are people really rational? Do we always take the most wise and sound course of action? Or are we more likely to stumble after one ill conceived decision after another. Fama attempts to adress this thorny issue by saying some people overeact and some people underact, so all in all the collective decision is towards the most rational one.
But humans, by nature, are hardly rational.
We drink, we smoke even though we know it will eventually kill us. We fall madly in love despite knowing we are gonna get out hearts broken. We buy a US10,000 hand beg just for the heck of it. And then we sell that same handbad for US500 cuz we cant pay rent. Rational? Try down right insane!
But you what the most insane thing is, Fama is actually, at least partially ,right. Human beings, for the most part, are creatures of sound mind . Underneath the impulsive nature, there is a voice of reason. It may be soft,even inaudible, but you can bet your pricey handbag its there. Some call it the voice of God, some swear its Fama's ghost. Whatever it is, i am glad its there. Being rational all the time is boring, but being perpetually irrational is suicide. Besides, if we were perpetually irrational, we would be rational, at least in our minds. Then once again, we are boring.
So, lets drink (and smoke) to our irrationality and rationality. We might not be efficient, but we sure know how to live life at the edge without going over the egde.
Unlike Newton, he couldnt name his theory after himself, since Fama's Law sounds so...errgggh. So he called it the Efficient Market Hypothesis. The financial world was in over itself cuz they finally had a law - and everyone knew a field is not really important unless it had a law or two. Now they can all act high and mighty in a I-have-a-law-nae-nae-nae-nae-nae kind of way.
I'm no economist, but what this theory basically says is the financial market (hence people) is omniscience (talk about being egoistical). Every information out there is already reflected in the prices of the assets. So for example, if you found out that company A was going to earn a huge profit, and you wanna buy its stock so you can cash in on its profit, DREAM ON! You are not gonna earn a profit because everybody else also know what you know, so they also rushing to buy the stock and driving up the price.
But cowmon! Are people really rational? Do we always take the most wise and sound course of action? Or are we more likely to stumble after one ill conceived decision after another. Fama attempts to adress this thorny issue by saying some people overeact and some people underact, so all in all the collective decision is towards the most rational one.
But humans, by nature, are hardly rational.
We drink, we smoke even though we know it will eventually kill us. We fall madly in love despite knowing we are gonna get out hearts broken. We buy a US10,000 hand beg just for the heck of it. And then we sell that same handbad for US500 cuz we cant pay rent. Rational? Try down right insane!
But you what the most insane thing is, Fama is actually, at least partially ,right. Human beings, for the most part, are creatures of sound mind . Underneath the impulsive nature, there is a voice of reason. It may be soft,even inaudible, but you can bet your pricey handbag its there. Some call it the voice of God, some swear its Fama's ghost. Whatever it is, i am glad its there. Being rational all the time is boring, but being perpetually irrational is suicide. Besides, if we were perpetually irrational, we would be rational, at least in our minds. Then once again, we are boring.
So, lets drink (and smoke) to our irrationality and rationality. We might not be efficient, but we sure know how to live life at the edge without going over the egde.
posted by Nashenee at 5:48 PM
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