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

Subject: Re: Market Predictions

Date: 8 Apr 1999 07:01:17 -0000

oldnasty@mindspring.com writes: > > The efficient market hypothesis does imply that future market > movements are not predictable, not because "everybody can't profit" > but because today's market prices reflect the market's best judgment > of future economic performance. So, absent additional information, > the odds that the market will rise equal the odds that it will fall. > > Thus the much debated "Random Walk Down Wall Street" > Hi Grinch. That's a good way to put it. The EMH, formally, does not require statistical independence of the marginal increments, (ie., returns.) The random walk model does. However, if returns are random, then the market is efficient. But it is not necessary that an efficient market be random. The apparent Pareto-Levy, (eg., stable Paretian, or fractal, a la Mandelbrot,) distribution of the marginal increments of the DJIA, S&P500, and NYSE Composite, as shown in: http://www.johncon.com/john/correspondence/981229233103.31169.html illustrates significant leptokurtosis in the equity markets, and would tend to imply that the markets are not efficient, (at least in the EMH sense,) since the variance would be undefined or infinite, and risk can not be equated to variance-a cornerstone paradigm of the EMH, (along with the presumptions that investors are rational-at least in the aggregate-and a linear relationship between cause and effect based on new information in the marketplace. Not to mention the paradigm that a large number of independent estimates results in a "fair" value of an equity by the aggregate market.) FWIW ... John BTW, I think the original question regarding efficiency of the markets was probably more directed at capital market theory, which is based on three similar concepts to the EMH; 1) the investors are rational, and require mean/variance efficiency to assess potential returns by probabilistic methodologies where risk = variance; 2) the markets are efficient, where prices reflect all public information and changes in price are not related, (ie., independent increments,); and 3) because of 1 and 2, the probabilities follow a random walk, ie., have a normal or Gaussian distribution-the returns have finite mean and variance. Unfortunately, the capital market theory can not accommodate leptokurtosis, as the EMH couldn't. A similar argument can be made against the Capital Asset Pricing Model, (CAPM), which relates variance of different equity prices to the standard deviation of the marginal increments, exactly as in the EMH. -- John Conover, john@email.johncon.com, http://www.johncon.com/

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