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ChrisA comments on Tsuyoku Naritai! (I Want To Become Stronger) - Less Wrong

111 Post author: Eliezer_Yudkowsky 27 March 2007 05:49PM

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Comment author: ChrisA 28 March 2007 08:58:44AM 0 points [-]

There seem to be lots of parallels between majoritarianism and the efficient market hypothesis in finance. In the efficient market hypothesis, it is entirely possible that a liquidly traded asset is mispriced, (similar to the possibility that the majority view is very wrong) however on average, according to the efficient market view, I maximise my chances of being right by accepting the current price of the asset as the correct price. Therefore the fact that a stock halved in price over a year is not a valid criticism of the efficient market theory, just as in majoritarianism the fact that the majority has been proven wrong is not a valid criticism of majoritarianism. The problem of free loading is inherent in the efficient market theory, if everyone accepts it then the market no longer is efficient. But there are enough people who have justified reasons not to invest on an efficient market basis to ensure that this does not happen as discussed below.

Some examples of justified reasons in differing from the majority view in the case of efficient markets are; 1) In the efficient market theorem, it is accepted that people with inside information can have successful trading strategies which deliver predictably above average returns. In the case of majoritarianism we would be justified holding a different view to the majority if we had inside information that the majority did not have (for instance we know the colour of someone eyes, when we know the majority do not). 2) A professional money manager of a non-index mutual fund is also justified in differing from the majority view since this is what he is paid to do. The parallel here for majoritarianism would be scientists or academics, who are paid to advance new theories, they receive compensation for differing from the majority, at least in their own area of speciality. 3) The final area where you might differ from the efficient market approach is when you gain some entertainment utility from investing (i.e. as a form of gambling, if I am honest, this is why I invest in single stocks). In the case of majoritarianism, the parallel is that you can chose to hold a view that is different from the majority if it brings you entertainment utility which outweighs the costs of holding a non-efficient view (religious views might be in this category).

Comment author: pnrjulius 30 June 2012 03:07:13AM 2 points [-]

Actually, realizing this parallel causes me to be even more dubious of the efficient market hypothesis.

As compelling as it may sound when you say it, this line or reasoning plainly doesn't work in scientific truth... so why should it work in finance?

Behavioral finance gives us plenty of reasons to think that whole markets can remain radically inefficient for long periods of time. What this means for the individual investor, I'm not sure. But what it means for the efficient market hypothesis? Death.