From: Robin Hanson (rhanson@gmu.edu)
Date: Sun Jun 15 2003 - 20:36:05 MDT
The best way I can explain the difficulty of beating the market is to point
out that most any trade you can make in the market is essentially a
zero-sum bet. You could just buy or sell the market portfolio, or a very
low risk asset, or any linear combination in between. *Any* other trade is
equivalent to such a trade plus a bet. In the bet the two sides in essence
each contribute some linear combination of the market portfolio and a
riskless asset; the winner gets to keep both contributions and the loser
gets nothing.
Now obviously it is possible to win bets. But it is also obvious that on
average bets are not won; with transaction costs the winners are more than
balanced by the losers. Now it can be rational to make bets to hedge
risks; that's what insurance is. But rational agents do not make bets with
each other for speculative reasons; making a bet is agreeing to disagree,
and rational agents don't do that.
Of course not everyone is rational; all that speculative trading going on
is proof of that. But when making a bet you should ask yourself why you
think you are *more* rational than the folks you are betting with. Yes,
some people are probably more rational that others. But clearly most
people over-estimate their own rationality. So do you feel lucky,
punk? I'm told that an old poker adage is that there is a fool at every
table; if you look around the table and don't see him, he's you.
(More on the irrationality of agreeing to disagree at
http://hanson.gmu.edu/deceive.pdf)
Robin Hanson rhanson@gmu.edu http://hanson.gmu.edu
Assistant Professor of Economics, George Mason University
MSN 1D3, Carow Hall, Fairfax VA 22030-4444
703-993-2326 FAX: 703-993-2323
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