Today on CNBC, correspondent Steve Leisman interviewed Burton Malkiel, author of A Random Walk Down Wall Street, now in something like its 11th Edition! This interview was of interest to the Random Stock Walker for reasons that are hopefully evident to readers of this blog.
In another blog piece (here) I commented on an interview with Andrew W. Lo who also wrote A Non-Random Walk Down Wall Street which takes the other side of the argument, namely that financial markets are more predictable than the random-walk hypothesis would suggest. What's interesting about this academic debate is what it says about the Financial Crisis of 2007. If markets are a random walk, then financial crises are simply part of their underlying random dynamic. If financial markets are predictable, why wasn't Prof. Lo able to see the financial crisis coming?
In the interview above, Burton Malkiel takes on one myth about the financial crisis, namely that faith in the efficient markets hypothesis led investors to take too much risk during the bubble. The efficient market hypothesis only means that markets provide the best possible information about prices. One corollary is that you can't beat the market because you don't have better information. One qualification, however, is that "best possible information" does not mean that the prices are right. The market is just as efficient at communicating "bubble" prices as it is in communicating "rational" prices.
The analysis leaves open the question of how to compute rational prices if the market won't do it for you. In the long run, Prof. Malkiel would argue that the market will eventually get it right. Unfortunately, that point will be too late for you to make any money off it!
From the perspective of attractor theory, which is the subject of this blog, both Prof. Lo and Prof. Malkiel are right. The market attractor is, I would argue, predictable while the current market position is not. The burning question is whether you can invest using these ideas?
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