Invulnerable zombies – the EMH

My book is due for publication in the US Fall, so work on my added sections on reanimation is starting to feel like one of those games where you have to kill all the zombies to get to the antidote before you fall victim yourself. Here’s another one – more on the way

ZombiesWalkEMH

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The ultimate zombie is one that is completely invulnerable. Neither special bullets nor hammer blows nor even decapitation can finally lay this undead being to rest. But dramatic logic requires that a zombie invulnerable to external threats must be subject to a subtle, but ultimately terminal, flaw that ends in its own destruction.

Ultimate zombies arise quite commonly in science and economics in the form of ideas that are immune from refutation. The classic examples arise from the popularised versions of Freudian psychology, centred on the Oedipus complex, named for the Greek tragic hero who unknowingly killed his father and married his mother. If a son hates his father, this is, obviously, evidence of the Oedipus complex. But, if he loves his father, this is explained as a repressed Oedipus complex. With rules like this, Freudian psychology can never be refuted.

But as a string of philosophers of science, being with the late Karl Popper, have shown, a theory that can’t be refuted by any conceivable evidence isn’t really a theory at all. All it says, in the end, is ‘anything can happen, and probably will’.

The global financial crisis, along with the earlier dotcom crisis has shown that, on any ordinary understanding of its terms, the efficient markets hypothesis can’t be right. Despite reaching a scale and sophistication unparalleled in history, global financial markets have shown themselves subject to the same manias, bubbles and busts that were seen in the Dutch tulip craze of the 17th century.

So supporters of the efficient markets hypothesis have sought a redefinition that would make it invulnerable to refutation. Their central argument is one that has already been discussed – if it is possible to diagnose the existence of a bubble, then it is possible to make arbitrarily large profits betting against it. And if someone like Warren Buffett has in fact done this, that can be put down to luck. Only if everybody can make money betting against the market can the EMH be wrong. But of course, it’s impossible for everyone to bet against the market – the market is just the aggregate of bets.

This argument in one form or another has been put forward by all the leading defenders of the EMH, notably including Eugene Fama and John Cochrane of Chicago and Scott Sumner of Bentley University

This set of observations from Scott Sumner in a blog post aptly titled ‘Defending the indefensible’ at least recognises the difficulties of the position

But why is Fama’s theory now in such disrepute? Because in the past ten years the world economy has seen two very important bubble-like patterns, indeed arguably the only two such market cycles in the US during my lifetime with macro significance. And they were both predicted by lots of experts because they violated popular theories of fundamentals. So start with the cognitive illusion that people have that makes them see bubbles even where there don’t exist. People think they have made accurate predictions because an upswing is always EVENTUALLY followed by a downturn. Then add in the fact that The Economist really did make accurate predictions in two of the most important events in modern history. Do you think it will be possible to convince them that they just got lucky? About as likely as a husband convincing an already suspicious wife that he is innocent after twice being caught in bed with two separate women. So I feel sorry for Fama. He’s probably right, but I don’t see how he could ever convince anyone in this environment. It would be like trying to convince someone that neoliberalism was the right policy in 1933.

As a well known blogger would say, ‘Indeed’. Looking at the evidence of the two gigantic bubbles of the last decade, it’s hard to see how Sumner maintains his own faith, and he never really gives an explanation, except to say that it’s easy to misperceive bubbles. As far as macroeconomics is concerned, the experience of the Great Depression and of the current Global Financial Crisis (which as Sumner implies, really began with the 2001 recessions) is pretty strong evidence that neoliberalism is not the right policy, at least not for all occasions and not in the forms that prevailed in the 1920s or the 1990s.

But the ultimate response to this invulnerable zombie must be the same as Popper on Freudian psychology. If the Great Depression, the dotcom boom and bust and the current Global Financial Crisis are all consistent with the efficient markets hypothesis, the hypothesis can’t tell us much of interest about anything. At most, it says that even when markets are way out of line with economic reality, it is hard to exploit this fact to make a profit. Most of us (me and Krugman at any rate) already knew that, and confined ourselves to getting out of stocks when they seemed absurdly overvalued.

87 thoughts on “Invulnerable zombies – the EMH

  1. @Andrew Reynolds

    I am not a Libertarian. This correction is free.

    I am surprised, I thought even you could have worked that one out, but then, unlike you, sometimes I find that I am wrong.

  2. I should have guessed. You do not have “an inability to ignore criticisms” – you seem to have that ability. Any more bombast / strawman stuff, or is that it and we can get back to actually discussing things?

  3. @Andrew Reynolds

    Oh, the whining of the wounded narcissist, how pleasant to the ears. And narcissists require but the smallest perturbation to unbalance, or is that unhinge? Please do continue to post, and to expose your (psychological) nakedness. Your are such an interesting specimen. So interesting to watch your response to stimuli.

    I do enjoy your cliched risible responses:
    “strawman stuff”
    “I thought you were looking in a mirror”
    “that does not mean I am wrong”
    “you did not answer the question”
    “I note you did not answer the question”
    “just because the NY Times says it, does not make it so”
    “just illustrates how desperate you are”
    “you again show your ignorance”

    How childlike and unthinking the cliched responses? How reminiscent of a petulant child remonstrating in a playground?

    As one of your best fans on this blog please continue your petulant frenzies. They, laying bare your psyche, and listening to your squeals, are constant sources of amusement. Please continue to pleasure your fans.

  4. @Andrew Reynolds
    Andy – people died due to Enrons market manipulations in the name of greed. Yes I feel sorry for the good people working at Enron but this was a power company that deliberately shut down power and extended shutdowns unnecessarily to make speculative gains on price movements caused by their shutdowns.

    Evil incarnate running the company Andy. As solid an argument against privatisation of essential utilities if ever there was one. Dont forget also the entire cities shutdown and people having to walk home from work in the freezing cold.

  5. Freelander,
    I thought the policy here was no personal abuse – I keep mine as low key as possible and strictly in response to the abuse of others. If you want a more “uptempo” stoush I suggest you find a bearpit somewhere. If PrQ is prepared to tolerate your abuse of me I will live with that, but I see no reason to respond with the sorts of infantile stuff you appear to be trying to attract.
    .
    Alice,
    I am not a great believer in “evil incarnate” and, having seen the silly games traders sometimes get up to to try and show how important they are, I can understand this. I would suggest, though, that you get behind the story and actaually see why they were able to do this. The way that the California energy market was privatised, to put it simply, sucked. Either it should not have been privatised (your preferred option) or is should have been done in a very different way.
    Essentially the California state government sold the whole lot off and then put the retailers in a strait-jacket – they could not raise prices without approval, but the producers could raise prices as and where they wanted to. The results were predictable, and, once juvenile traders on bonus plans got involved, they were the tragic ones you identified. The traders were smarter than the people in the regulatory department and knew the regulations better and so they thought playing games to increase their bonuses was a good thing for them to do – essentially to “punish” the regulators for being so stupid.
    My position on this is simple – if you are going to privatise or deregulate you need to both privatise and deregulate. You should not do one without the other in this sort of crucial industry as the results are almost uniformly silly or, as in this case, tragic.

  6. @Andrew Reynolds

    Oh, the whining and self justification. Clearly you had a very good think over this post. Poor you, how unfairly treated. Unfairly, but me, by JQ, by the world that denies recognition. Unfairness not really a word in the Libertarian lexicon. Real Libertarians don’t recognise ‘unfairness’. Very consistent with the disorder – the sense of entitlement, the disregard for others but overblown regard for self. Sure, you ‘only’ abuse others ‘low key’ and ‘strictly in response to the abuse of others’. Again, so consistent. So sensitive to your own feelings and insensitive to others. Real and imagined slights, so magnified, and your abuse of others so minimised. Well I don’t mind receiving childish abuse. It somewhat amuses me what some people do. Interesting specimens are often worthy of study.

    In reality you have not been abused. You simply have been provided a self revelation, albeit a painful one.

    Why not engage in some self reflection, which would be an unusual experience for you, and read your responses, not to me, but to others on this blog, and imagine that you had had those responses made to you and then test the validity of “no personal abuse – I keep mine as low key as possible and strictly in response to the abuse of others” statement. Maybe you will learn something, but learning seems to be something you are highly resistant to.

    Re: your response to Alice. Your characterisation of the Californian crisis is somewhat at variance with the reality. Typical, blame the victim. Sure the state government had been wrong to engage in the market worship privatisation and ‘light handed’ regulation measures ‘true believers’ proposed, but what was done to them was ‘evil incarnate’ – done by evil greedy criminally minded people.

    Back to the topic, the EMH has well and truly been refuted, again and again. Only the most evidence resistant could still hold to it. Always risible to hear the wiggling and rationalisations of obstinate adherents. Again, their responses often worthy of study.

  7. @Andrew Reynolds

    One or two more for the trite list:
    “strawman stuff”
    “I thought you were looking in a mirror”
    “that does not mean I am wrong”
    “you did not answer the question”
    “I note you did not answer the question”
    “just because the NY Times says it, does not make it so”
    “just illustrates how desperate you are”
    “you again show your ignorance”
    “If there is any narcissism to be seen it is in that mirror next to you.”
    “Get a life.”
    “Well – it was more than you had to put into your previous one.”
    “At least mine had some worthwhile advice in it.”
    I like that you have put two days worth into your latest effort.

  8. @Andrew Reynolds

    “strawman stuff”
    “I thought you were looking in a mirror”
    “that does not mean I am wrong”
    “you did not answer the question”
    “I note you did not answer the question”
    “just because the NY Times says it, does not make it so”
    “just illustrates how desperate you are”
    “you again show your ignorance”
    “If there is any narcissism to be seen it is in that mirror next to you.”
    “Get a life.”
    “Well – it was more than you had to put into your previous one.”
    “At least mine had some worthwhile advice in it.”
    “You really do need to get a life.”

    Please continue your posts. I am enjoying your banalothon.

    By the way, I haven’t yet explained what your ‘south park’ avatar reveals.

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