Has Burton Malkiel Abandoned the Efficient Market Hypothesis?
Long-term readers of Angrybear know I often appeal to the logic of the Efficient Market Hypothesis (EMH). In comments to a recent post, one reader suggested EMH was so outdated that even Burton Malkiel has abandoned it. That claim surprised me in light of his April 2003 paper The Efficient Market Hypothesis and Its Critics:
The intellectual dominance of the efficient-market revolution has more been challenged by economists who stress psychological and behavioral elements of stock-price determination and by econometricians who argue that stock returns are, to a considerable extent, predictable. This survey examines the attacks on the efficient-market hypothesis and the relationship between predictability and efficiency. I conclude that our stock markets are more efficient and less predictable than many recent academic papers would have us believe … For me, the most direct and most convincing tests of market efficiency are direct tests of the ability of professional fund managers to outperform the market as a whole. Surely, if market prices were determined by irrational investors and systematically deviated from rational estimates of the present value of corporations, and if it was easy to spot predictable patterns in security returns or anomalous security prices, then professional fund managers should be able to beat the market … A remarkably large body of evidence suggesting that professional investment managers are not able to outperform index funds that simply buy and hold the broad stock market portfolio.
A couple of years later, Malkiel wrote Reflections on the Efficient Market Hypothesis: 30 Years Later:
In recent years financial economists have increasingly questioned the efficient market hypothesis. But surely if market prices were often irrational and if market returns were as predictable as some critics have claimed, then professionally managed investment funds should easily be able to outdistance a passive index fund. This paper shows that professional investment managers, both in The U.S. and abroad, do not outperform their index benchmarks and provides evidence that by and large market prices do seem to reflect all available information.
I’m not aware of a subsequent paper where Professor Malkiel has abandoned his long held view – but I’d appreciate it if someone would provide us with his latest thoughts.
I almost have the impression that some people here (including pgl) take the EMH seriously.
Come on, you must be kidding. Asset price volatility is vastly too high to be explained by news about fundamentals (see Shiller — everything he wrote). The Price Earnings anomaly is older than the CAPM. Fama has redefined the EMH so that it isn’t a hypothesis with predictable risk ajusted returns called “weightings”.
There are two different questions — is it easy to beat the market and are prices close to the prices there would be if the EMH held (which are the prices there would be if everyone had rational expectations). If asset prices are affected by totally irrational noise which is stochastic and persistent (say an AR(1) with an autoregressive component close to 1) then it is hard to beat the market and the EMH is fundamentally wrong.
I really didn’t know that anyone but Fama and maybe Cochrane still claimed to believe the EMH and, I note, Fama redefined it to be unfalsifiable. Fama himself has presented data which overwhelmingly reject the EMH (as he defined it before redefining it to be meaningless).
“The best thing about Eugene Fama is that his theoretical views have no effect on his research” — Andrei Shleifer.
I personally consider the EMH to have the same epistemogical standing as the flat earth hypothesis.