Efficient Market Hypothesis Re-examined; Wall Street Still Pursues Mammon

One of the great theories that seems to be approaching old age and senility is the efficient market hypothesis. Wikipedia describes the theory as follows:

In finance, the efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient", or that prices on traded assets (e.g., stocks, bonds, or property) already reflect all known information, and instantly change to reflect new information. Therefore, according to theory, it is impossible to consistently outperform the market by using any information that the market already knows, except through luck.

(Wikipedia)

We've always thought the theory bunk and rather defiant of the human element and human nature. People neither absorb available information at the same time, or process it in rational fashion. Nor does the available information always reflect the underlying truth of any given asset.

Via the New York Times we have academics now exploring the human element that makes economic and risk modeling less precise. If this is part of the outcome of the near collapse of the financial markets, it is a welcome philosophical adjustment in our opinion.

In related observations, there have been any number of articles demonstrating some surprise or resignation that Wall Street is back to its old ways, and resuming the pursuit of massive profits. An article last week (also N.Y. Times) noted that Wall Street is now hoping to make a market of people's insurance policies, packaging them into securities.

So the wheel goes round and round.

In the the efficient markets article, the interest among college students (at least at MIT) remains high for the very skills that helped contribute to past difficulties, all though this time the hope is to reinvent the wheel:

When a bridge over a river collapses, the engineers who built the bridge have to take responsibility. But typically, critics call for improvement and smarter, better-trained engineers — not fewer of them. The same pattern seems to apply to financial engineers. At M.I.T., the Sloan School of Management is starting a one-year master’s in finance this fall because the field has become too complex to be adequately covered as part of a traditional M.B.A. program, and because of student demand. The new finance program, Mr. Lo noted, had 179 applicants for 25 places. 

In the aftermath of the economic crisis, financial engineers, experts say, will probably shift more to risk management and econometric analysis and concentrate less on devising exotic new instruments. Still, the recent efforts by investment banks to create a trading market for “life settlements,” life insurance policies that the ill or elderly sell for cash, suggest that inventive sales people are browsing for new asset classes to securitize, bundle and trade.

(N.Y.Times)

It really is about time people dispensed with standard EMH theories altogether. It's also probably about time that Washington seriously writes some financial legislation that limits leverage and speculation by major banks.