Wednesday, 12 September 2007

Beating the monkey

No more whinging - that is unless BA upset me again. The question today is: are the capital markets efficient? What this is taken to mean is do they process price relevant signals into securities instantly and without bias. There is the rather broader question as to whether market are efficient in their job of allocating capital around the market - that I do not want to get into here. What I am interested in do share prices react instantly and unbiasedly to share prices?

Quite obviously the answer is no. Empirical studies have demonstrated numerous divergences from perfect efficiency. If we mine sufficient data we can find the wrinkles. The empirical evidence does support the efficiency hypothesis to a high degree but when we look at past performance we can see that various trading strategies would have worked if applied in the past. They would have worked but rarely by much. Oddly, those individuals and organisations we would have expected to have the skill to develop trading strategies that would consistently beat the market do not appear to be able to do so. Indeed, when I look at the average fund manager they typically undershoot the performance of a monkey - employed to throw darts at the share price listings in the FT - by quite a substantial margin. So if they cannot beat the market consistently that suggests that the search for trading strategies is not a profitable activity per se.

But putting that all to one side perhaps a better question is: no matter how inefficient the market is it more efficient than any given individual, committee, cabinet meetint, politburo, share club or board of directors could ever be? Here I think there is a good answer and it is yes.

The reason will follow...........

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