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One of the main tenets of the Efficient Market Hypothesis (Random Walk) is the assumed rationality of an investor in the market. Economists refer to this creature as the "utility-maximizing agent." I'm not sure I really understand it, but I think what they mean is that people will always act in an economically reasonable manner in light of the circumstances they face. Many who criticize the academics for their Random Walk theory point to the people in Holland in the 1600s who were caught up in what is popularly called the tulip bulb craze. We read Charles Mackay's 1841 description of this investment boom/bubble in an earlier blog.
Professor Robert J. Shiller, a Yale economics professor and author, discussed the tulip bubble in his 2000 book, Irrational Exuberance, and argued that it was not necessarily an example of irrational behavior as follows:
But Mackay offered no concrete evidence that people were behaving insensibly and moreover could not show that the rage had anything to do with any speculative mispricing. Garber (Peter Garber is an economics researcher and author) points out that the really high prices were for rare varieties of tulips that had unusual patterns of coloration due, we now know, to infection by a mosaic virus. These tulips could not be readily propagated and were genuinely rare. People in Holland at the time highly valued these unusual tulips, which had great significance in their culture. Thus there is nothing more foolish about their high tulip prices than about the high prices that rare art objects or other collectibles often fetch today. Moreover, the price behavior of the tulip bulbs looks rather like that of the prices of many other speculative assets; they did not boom once, crash once, and then stay down as some simpler stories suggest. Prices of tulips went up and down numerous times, just as stock prices do all the time. These price changes could well have had some rational basis in new information about public demand for rare flowers becoming known to investors over time.*
In 1940 author Fred Schwed, Jr. wrote a hilarious account of Wall Street titled, Where Are the Customer's Yachts? or A Good Hard Look At Wall Street. It is said that he worked on Wall Street for only a couple of years in the 1920s, but he apparently figured out its foibles and eccentricities in that short time. As Schwed saw it, there were not that many "utility maximizing agents" on the Street when he was there. He summarized Wall Street's appetite for market booms as follows:
In attempting to find out just what, if anything, was good in the good old days it is necessary to determine when the good old days were. In some simple, but not straightforward, Wall Street minds, they were any days that preceded the Securities and Exchange Commission, when there weren't no ten commandments and a man could raise a thirst. Oh for the days when the most important rules were "Don't rebate on commissions," "Don't shoot the specialists," and "Don't smoke opium on the floor during trading hours."
It would be more correct and more honest to recognize that the good old days were simply boom days, like the booms of the late twenties, the late teens and the late nineteenth century.
In our moments of sober thought we all realize that booms are bad things, not good. But nearly all of us have a secret hankering for another one. "Another little orgy wouldn't do us any harm," is the feeling that persists both downtown and up. This is quite human, because in the last boom we acted so silly. If we are old enough we probably acted silly in the last three. We either got in too late, or out too late, or both. But now that we are experienced, just give us one more shot at a good reliable runaway boom!**
It seems to me that the answer to whether the market is rational/efficient or irrational/inefficient may be based simply on your personal beliefs about the subject. Ample evidence would appear to be available to buttress either position.
We will conclude our look at Random Walk in the next blog.
* Excerpt from SHILLER, ROBERT J.; IRRATIONAL EXUBERANCE, copyright 2000 Robert J. Shiller, published by Princeton University Press, reprinted by permission of Princeton University Press.
** Excerpts from Where Are the Customer's Yachts? or A Good Hard Look At Wall Street, Fred Schwed, Jr., copyright 1940, republished by John Wiley & Sons, Inc, pages 148-149.
Comments are always welcome.
One of the main tenets of the Efficient Market Hypothesis (Random Walk) is the assumed rationality of an investor in the market. Economists refer to this creature as the "utility-maximizing agent." I'm not sure I really understand it, but I think what they mean is that people will always act in an economically reasonable manner in light of the circumstances they face. Many who criticize the academics for their Random Walk theory point to the people in Holland in the 1600s who were caught up in what is popularly called the tulip bulb craze. We read Charles Mackay's 1841 description of this investment boom/bubble in an earlier blog.
Professor Robert J. Shiller, a Yale economics professor and author, discussed the tulip bubble in his 2000 book, Irrational Exuberance, and argued that it was not necessarily an example of irrational behavior as follows:
But Mackay offered no concrete evidence that people were behaving insensibly and moreover could not show that the rage had anything to do with any speculative mispricing. Garber (Peter Garber is an economics researcher and author) points out that the really high prices were for rare varieties of tulips that had unusual patterns of coloration due, we now know, to infection by a mosaic virus. These tulips could not be readily propagated and were genuinely rare. People in Holland at the time highly valued these unusual tulips, which had great significance in their culture. Thus there is nothing more foolish about their high tulip prices than about the high prices that rare art objects or other collectibles often fetch today. Moreover, the price behavior of the tulip bulbs looks rather like that of the prices of many other speculative assets; they did not boom once, crash once, and then stay down as some simpler stories suggest. Prices of tulips went up and down numerous times, just as stock prices do all the time. These price changes could well have had some rational basis in new information about public demand for rare flowers becoming known to investors over time.*
In 1940 author Fred Schwed, Jr. wrote a hilarious account of Wall Street titled, Where Are the Customer's Yachts? or A Good Hard Look At Wall Street. It is said that he worked on Wall Street for only a couple of years in the 1920s, but he apparently figured out its foibles and eccentricities in that short time. As Schwed saw it, there were not that many "utility maximizing agents" on the Street when he was there. He summarized Wall Street's appetite for market booms as follows:
In attempting to find out just what, if anything, was good in the good old days it is necessary to determine when the good old days were. In some simple, but not straightforward, Wall Street minds, they were any days that preceded the Securities and Exchange Commission, when there weren't no ten commandments and a man could raise a thirst. Oh for the days when the most important rules were "Don't rebate on commissions," "Don't shoot the specialists," and "Don't smoke opium on the floor during trading hours."
It would be more correct and more honest to recognize that the good old days were simply boom days, like the booms of the late twenties, the late teens and the late nineteenth century.
In our moments of sober thought we all realize that booms are bad things, not good. But nearly all of us have a secret hankering for another one. "Another little orgy wouldn't do us any harm," is the feeling that persists both downtown and up. This is quite human, because in the last boom we acted so silly. If we are old enough we probably acted silly in the last three. We either got in too late, or out too late, or both. But now that we are experienced, just give us one more shot at a good reliable runaway boom!**
It seems to me that the answer to whether the market is rational/efficient or irrational/inefficient may be based simply on your personal beliefs about the subject. Ample evidence would appear to be available to buttress either position.
We will conclude our look at Random Walk in the next blog.
* Excerpt from SHILLER, ROBERT J.; IRRATIONAL EXUBERANCE, copyright 2000 Robert J. Shiller, published by Princeton University Press, reprinted by permission of Princeton University Press.
** Excerpts from Where Are the Customer's Yachts? or A Good Hard Look At Wall Street, Fred Schwed, Jr., copyright 1940, republished by John Wiley & Sons, Inc, pages 148-149.
Comments are always welcome.
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