From: Peter C. McCluskey (pcm@rahul.net)
Date: Thu Jun 12 2003 - 23:29:17 MDT
mez@apexnano.com (Ramez Naam) writes:
>I'm skeptical of the efficient market theory. It treats all decision
>makers as rational entities with access to the same information and
>the same response to that information.
>
>None of those three assumptions is correct. Humans are emotional
>decision makers. There are indeed differences in the information
>investors have access to. And given the same information, different
>investors would make different decisions based upon their individual
>analysis, risk tolerance, and of course that emotional factor listed
>above.
I don't think differing information can explain inefficient prices, for
reasons that were explained in the recent threads about it being irrational
for people to disagree. And random emotions wouldn't do much either. I
think you need to understand the reasons behind the emotions to explain
persistent patterns of inefficient prices.
People want to hold popular beliefs. It's easier to feel comfortable
holding stocks of widely respected companies than it is to hold stocks
that nobody has heard of. This creates a bandwagon effect.
People are biased to believe that prices today normally ought to be the same
as they have been on previous days. This attitude sometimes helps you to
negotiate a better price when you're trying to buy from a specific person,
but costs you in anonymous markets. For a good explanation of this phenomenon,
see:
http://www.daviddfriedman.com/Academic/econ_and_evol_psych/economics_and_evol_psych.html
This causes stock prices to be sometimes slow to respond to new information,
which causes trend following to be good on average. Once investors notice
that fact, they cause trends to extend too far.
-- ------------------------------------------------------------------------------ Peter McCluskey | "To announce that there must be no criticism of http://www.rahul.net/pcm | the President, or that we are to stand by the | President right or wrong, is not only unpatriotic | and servile, but morally treasonable to the | American public." - Theodore Roosevelt
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