On the impossibility of efficient markets

17 Jan, 2020 at 18:46 | Posted in Economics | 6 Comments

In general the price system does not reveal all the information about “the true value” of the risky asset …

tumblr_n6vk0tAVwh1rlnhn7o1_500The only way informed traders can earn a return on their activity of information gathering, is if they can use their information to take positions in the market which are “better” than the positions of uninformed traders. “Efficient Markets” theorists have claimed that “at any time prices fully reflect all available information” … If this were so then informed traders could not earn a return on their information.

When the efficient markets hypothesis is true and information is costly, competitive markets break down … As soon as the assumptions of the conventional perfect capital markets model are modified to allow even a slight amount of information imperfection and a slight cost of information, the traditional theory becomes untenable. There cannot be as many securities as states of nature. For if there were, competitive equilibrium would not exist …

Because information is costly, prices cannot perfectly reflect the information which is available, since if it did, those who spent resources to obtain it would receive no compensation. There is a fundamental conflict between the efficiency with which markets spread information and the incentives to acquire information.

Sanford Grossman & Joseph Stiglitz

Here (in Swedish) is my own take on the paradox.


  1. Fischer Black in “Noise” guessed that prices were efficient to within a factor of two, 90% of the time. So if oil is “really” $50/barrel, it could jump from $25 to $100 due to noise alone, and 10% of the time could move outside that broad range. That’s 300% (or more) inflation due to pricing inefficiency (not oil scarcity). A chart of historical oil prices seems to support Black’s hypothesis: http://chartsbin.com/view/oau
    When economists and traders question the Efficient Market Hypothesis my next question is: why fear inflation, then? Inflation’s unwanted distributional effects can be counteracted by printing money and distributing it equally. Thus real purchasing power can be kept stable even as nominal prices increase unboundedly.
    When repo price inflation spiked in September 2019, the Fed stepped in to print money to bring prices down. The Fed printed money (and is still printing) to end repo price hyperinflation.
    If the EMH is wrong, inflation should not be a constraint on public policy; we can print our way out of hyperinflation. (Inflation can be defined as demand for the world’s best money, and the Fed can meet infinite demand with infinite supply.)
    In an earlier discussion on this site, Bruce Wilder said there were still reasons to fear inflation even if the EMH is wrong. Upon reflection, it seems to me that this argument really amounts to: I’m getting an arbitrarily high price for my labor now and I’m afraid my relative value will go down if runaway inflation strikes. But many of us are getting an arbitrarily low price for our labor now. I understand that well-paid economists are afraid of losing something if we print money to establish a floor on income for everyone, but if we index their salaries too they won’t lose anything in real purchasing power terms.
    If production is idled as a result of printing money to bring everyone up to a floor level of income, then that simply confirms that the EMH is wrong and we should not be relying on markets to provision us with real goods; we should be implementing public policies now that encourage self-provisioning in ways markets won’t, because markets make more profit by keeping production centralized (i.e., under their control) and selling subscriptions.
    > The One-Straw Revolution, in short, was Fukuoka’s plea for man to reexamine his relationship with nature in its entirety. In his most utopian vision all people would be farmers. If each family in Japan were allotted 1.25 acres of arable land and practiced natural farming, not only could each farmer support his family, he wrote, but each “would also have plenty of time for leisure and social activities within the village community. I think,” he added, “this is the most direct path toward making this country a happy, pleasant land.”

  2. I have been arguing this since I started teaching environmental communication in 1992. Either you can have perfect information OR you can have a market for information (copyright and patents being the major expression of this), you can’t have both. This makes the conditions for Pareto optimality internally contradictory.

  3. Efficient market hypothesis have no base grounding or founding in empirical data what so ever.Pure ideology.As shown here for example : https://core.ac.uk/download/pdf/56368516.pdf

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