From: John Conover <john@email.johncon.com>

Subject: Re: Efficient Markets Hypothesis

Date: 13 Feb 2001 23:15:25 GMT

It is a paradox. I think the enigma was first brought up by John Casti in "Searching for Certainty", John L. Casti, William Morrow, New York, New York, 1990, ISBN 0-688-08980-1, pp. 204, last paragraph: The perceptive reader will have already noticed that there's something inherently paradoxical about the EMH. On the one hand, the EMH says that it's useless to gather information; it will do you no good at all in the development of a trading strategy that will outperform the market, [since the EMH assumes the Bachelier random walk theories, (RWT), as a paradigm of stock price fluctuations.] On the other hand, the EMH says that all available information has already been factored into the price of a stock. But how can this happen if no one gathers information? The fact is, it can't. Therefore, in order for the EMH to be valid, there must be a sufficiently large number of traders who don't believe it! So it can only be true if you don't think it's true-a stock market version of the famous Liar's Paradox ("All Cretans are liars. I am a Cretan. I'm lying"). Casti is an applied mathematician, (RAND, IIASA, SFI,) and the book is about scientific explanations and predictions-just to let you know where he is coming from. As to where this leaves the EMH, any logical system, (at least as complex as the arithmetic,) will be either incomplete or inconsistent, (a la Godel's self-referential indeterminism,) and economics, (and/or equity price fluctuations,) is probably at least that complex. Bottom line, that means that any theory of stock price fluctuations, like the EMH, will contain logical contradictions, (i.e., paradoxes-where two mutually exclusive statements in the theory are perfectly defensible.) Its probably true of most concepts in economic theory, (and most things in life, for that matter.) John BTW, Martin, the EMH does not assume that traders are rational, (its an often quoted misconception; what does the word rational mean in a paradoxical environment?) The EMH only assumes Bachelier's so-called random walk theory as a mathematical model of stock price fluctuations. Its a reasonable assumption, (depending on who is telling the story, of course,) since the RWT is the only known *_stable_* stochastic solution; if everyone knew the fluctuations were RWT, the fluctuations would still be RWT. Not so for the other stochastic solutions-where the market inefficiencies can be exploited to an advantage, (for awhile, at least, until the advantage is arbitraged away.) Martin Sewell writes: > The EMH assumes that all traders are rational. > The EMH states that markets are efficient. > > A rational investor would not trade in an efficient market. > So there would be no market...and therefore no EMH. > > Where does this leave the EMH? -- John Conover, john@email.johncon.com, http://www.johncon.com/

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