Sunday 2011-03-13

Inefficient Markets by Andrei Shleifer

Shleifer was one of the original Noise-trading paper authors, along with Larry Summers, Brad DeLong, and Robert Waldmann. This book of lecture notes shows Shleifer's attack on the Efficient Markets Hypothesis. EMH-adherents will discount any counter-examples by trying to show that the trader in question had more risk than was originally supposed. At one point, Larry Summers essentially said that EMHers were cheating because it takes a lot of data to distinguish between mean-reversion and random-walk.

Lots of intellectual acrimony over very old issues ( TheSchoolOfAthens )....

He (Richard Roll) finds the average adjusted R2s to be only 0.35 with monthly data and 0.2 wiht daily data, suggesting that movements in prices of individual stockes are largely unaccounted for by public news or by movements in potential substitutes.
-- Are Financial Markets Efficient?
Summers argues that many tests of market efficiency have low power in discriminating against plausible forms of inefficiency.
-- Are Financial Markets Efficient?
Actually, the optimal arbitrage strategy is not obviously to buy and sel the same amount of cheap and expensive shares, respectively. Michael Rashes (1998, 'Massively confused investors making conspicuously ignorant choices') works out the optimal arbitrage strategy, and applies it to a number of examples, including Royal Dutch Shell.
-- Noise Trader Risk in Financial Markets