Saturday, January 16, 2010

Does it matter whether markets are efficient?

Reading the series of New Yorker articles with Chicago economics/finance faculty, I was struck by how frequently the idea of of efficient markets came up.  Something like, "How does the recent financial crisis influence your thoughts about market efficiency."  And the general response seems to be "Not very much."

There's a lot of criticism of academics and their rigid beliefs.  For example, you could stroll around the Motley Fool discussion boards and find numerous references to critiques of the theory.  It's a lot of wasted words, oftentimes with people talking past one another and arguing over semantics rather than ideas.  But my two pervasive thoughts on this are:

  1. It would generate much less disagreement to describe markets as extremely competitive rather than as describing them as "efficient" or "inefficient".
  2. Believing that markets are efficient is much less likely to cause troubles in your life than believing that markets are inefficient.**  If you're going to insist on a black-and-white world, you're better off believing in perfect efficiency.

**Not true if you are a credit analyst relying on spreads for your ratings.

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