Eugene Fama was one of three winners of the Nobel Prize for Economics this year.
His hypothesis regarding the efficiency of financial markets is indeed
elegant (which sometimes is enough for an award to be made) but it is
also utterly and completely wrong.
Not particularly impressed with his Fama-French Three-Factor Model either (but more on that later).
If there were no government interferences, no psychopathies, no
behavioural irrationalities, no corruptions nor criminalities and if
market sectors didn't always evolve towards maturity, he would be right.
But as these inputs drive all markets, the laureate is surely wrong.
Fama's Efficient Markets Hypothesis was put forward in 1970 and formed
an intellectual basis for the shock doctrine disaster neo-capitalism
that the world has experienced since.
By being a part of the "intellectual" framework gathered as an neo-con
edifice at the University of Chicago, Fama bears some responsibility for
this sociopathic system.
So, what is Gene's hypothesis and why is it incorrect?
The Efficient Markets Hypothesis is split into three levels - strong-form, semi-strong-form and weak-form efficiency.
Strong-form suggests that market prices reflect all information, public
and private, and it is not possible for anyone to earn excess returns.
In semi-stong-form, prices adjust to new information rapidly and rationally.
While in weak-form structures, prices simply follow a random walk.
Before we go any further we need to look at the architecture of markets.
The public markets are just the top of an iceberg of submerged Dark Pool
markets - there are hundreds of unregulated Dark Pools where insiders
trade against insiders in markets that the public only sees when an
excess of over-enthusiasm occurs. It is in these markets that the big
market plays are made not the public ones.
For all assessments of Fama's Hypothesis, therefore, it will need to be
addressed on two levels - the public markets and the Dark Pools.
1) The most dominant input to the wrongness of Fama's Hypothesis is behaviouralism.
Work in the sixties by Daniel Kahnemann, Amos Tversky, Paul Slovic and
Richard Thaler had already introduced psychology to the market and, in
1979, Kahnemann and Tversky developed Prospect Theory which represented
the final psychological nail in the coffin of Efficient Markets.
Investors do not behave in a rational manner in the marketplace for a
whole continuum of different reasons that both exist within themselves
and also interact in complex ways between themselves to produce the
behaviours that we project. Market prices represent mass human
psychology far more than they do unproved economic fundamentals.
So by 1979, Fama's Hypothesis should have been put to bed...
... unfortunately, it took the blinkered Chicago School until 2007 to
acknowledge the impact of behaviouralism in markets, attempting to
convince us in the meantime that an efficient pricing infrastructure
underpinned the alleged validity of Friedmanian late capitalism..
Slavoj Žižek: "The problem is today when you have chaos or disorder, people lose their cognitive mapping."
2) All of the information is not in the market. Even if behaviouralism
did not exist and we were all perfectly rational in all of our
decision-making, efficient markets would be compromised on all three
levels of Fama's efficiency hierarchy.
Public markets are largely inefficient being too far from the core Dark
Pools to be benefiting instantaneously to the flow of real information.
The public markets offer a distilled filtered form of this driving
underground Dark Pool marketplace. Dark Pool trading strategies become
converted into a holistic market strategy as Dark Pool liabilities are
hedged in the public sphere.
What about the Dark Pools?
Are they a proof of Fama efficiencies?
No.
Behaviouralism is a "plug in" in any market, public or Dark Pool.
Additionally, the information flow in Dark Pools is, by its very nature, opaque.
Proxy trading, algorithmic distortions, hidden players away from the
table, consortia strategies, disinformational trading, cornered markets
etc etc.
At any given time, the market tends to inefficiency.
As mature markets might evolve into anything the primary operators desire, the price can be anything too.
Mature markets (and these are the ones most traded in the Dark Pools)
are largely under the absolute control of a small grouping of
operations, think OPEC. Individual members of OPEC have their own hidden
agendas over and above the shared agenda with fellow members. Even when
the structure is held in place with extra robustness due to government
scaffolding around the market, the major player(s) is/are still able to
make the market whatever they desire whenever they desire.
In effect monopolistic corruption distorts any semblance of efficiency
in the market while duopolistic or cartel behaviour offers a slightly
diluted version of the same.
3) Disaster capitalism undermines any efficiency in any financial market.
The Friedmanian disaster capitalism complex thrives on chaos. When a
disaster strikes or, as in the case of Chile, is created, the Chicago
school Hayekians move in with their shock tactics to further destabilise
an already destabilised people. As US security entities move into the
vacuum, the markets are utterly chaotic. Although some efficiency and
robustness is added to the marketplace ironically by the strategies of
these security operations (the same template being micro-adjusted from
territory to territory) the holistic performance of the markets is
driven by irrationalities and the efficiencies fall off the bottom of
Fama's ratings chart.
4) Private information is introduced to the market in a variety of
strategies that, by their very nature, imply market inefficiencies being
created for the advantage of Dark Pool operations.
Knowledge within a company, governmental or central bank policies,
trading disinformation for future profits, competitive market poker play
all are based around the possession of the ultimate power play for the
marketplace. Just think of the variety of ways in which, say, Ben
Bernanke could have utilised his absolute knowledge of the variables
related to quantitative easing. An individual, with evolving strategies,
could make money without the full reality hitting the market by placing
trades laterally and peripherally.
Noam Chomsky would call this "cogntive regulatory capture" and it is a structure typical of late capitalism.
5) The most obvious way in which financial markets are inefficient is by
their refusal to accept the cost of externalities in the price of an
asset.
How on earth can a price be efficient in the holistic sense if
externalities are not included in the calculation? The price can only be
considered in any way efficient in short time frames as, when the true
costs are included, the asset value is very different indeed. The timing
of this market implosion can be an unknown variable.
Friedmanism underprices risk and ignores externalities.
The eventual impact of these externalities is infrastructurally significant.
Andrew Haldane, who should have been made governor of the Bank of England, calls this "disaster myopia".
Disaster myopia in disaster capitalism complex!
Although Dark Pools are displaced up the efficiency hierarchy due to
lack of time lag and the primary element in the insider trading, the
market increase in efficiency is only marginal and only due to
corrupting inputs being introduced to the market price.
If all corrupt inputs in a mature market could be known and assessed
both singly and in association with one another, only then might a
corrupt market approach strong-form efficiency and in a non-regulated
marketplace this is simply not going to occur.
Which brings us to the conclusion of yet another aspect of the fake of Friedmanism.
Fama's only other claim to fame is the already mentioned Fama-French Three-Factor Model.
This attempts to replace the old Capital Asset Pricing Model (which, by the way, is also inadequate).
Needless to say the Three-Factor model doesn't work as it ignores corruption and behaviouralism.
Entertainingly, Foye, Mramor and Pahor (2013) have shown an improvement
in the performance of the Fama-French model if one of the terms is
replaced by a term that acts as a proxy for accounting manipulation!
These papers are amongst the first tentative steps of economics crawling towards holistically analysing the hyperreality.
Benoît
Mandelbrot: "Financial economics, as a discipline, is where Chemistry
was in the 16th century: a messy compendium of proven know-how, misty
folk wisdom, and unexamined assumptions and grandiose speculation."
As a former pupil of Mandelbrot, Fama should know better...
... grandiose models, unexamined inputs, misty economic wisdom mixed with the status quo.
And, anyway, as economics in rather dubious fashion claims to be a science, let's address it as such...
Michel Foucault: "If one recognises in science only the linear
accumulation of truths or the orthogenesis of reason, and fails to
recognise in it the discursive practice that has its own levels, its own
thresholds, its own various ruptures, one can describe only a single
historical division, which one adopts as a model to be applied at all
times for all forms of knowledge."
