<p>"Behavioral finance offers compelling evidence against EMT."</p>
<p>Oh really? Since when? Example please, for such a bold statement?</p>
<p>FWIW, I'll avoid an argument regarding whether Fama was first or the most important in his efforts. These are not arguments worth spending time on, especially when answers involve value judgements. CB, you may feel Fama's work was neither first nor significant. Fine.</p>
<p>This is so unfair..much of his Nobel-winning research was conducted at Northwestern but now Chicago got all the credits. :(</p>
<p>newmassdad,</p>
<p>Greenspan cites the "irrational exuberance" of the '90s as behavioral evidence v. EMT</p>
<p>Also, the presence of CEFs that trade at huge premiums/discounts to NAV is rather compelling: See <a href="http://en.wikipedia.org/wiki/Closed_end_fund#Discounts_and_Premiums%5B/url%5D">http://en.wikipedia.org/wiki/Closed_end_fund#Discounts_and_Premiums</a></p>
<p>it is kind of ridiculous how he was at Northwestern for over 20+ years and then goes to chicago for the last few years, and NU doesn't even get the spotlight...kinda funny but sad....</p>
<p>CB, </p>
<p>think of it this way: EMT (and finance/portfolio theory) say that the price of a security incorporates all publicly available information. But the theories also state that the price is based on investors EXPECTATIONS of future returns. After all, securities pricing is forward looking, with exceptions to be discussed below. Greenspan's comments can be interpreted to mean that investors expectations of future returns were irrational, not that current pricing was irrational. In other words, based on the then current expectations or assumptions regarding future earnigns, the then current share price was rational, and the markets efficient. </p>
<p>Regarding CEFs that trade at a discount or premium, this is no surprise and has been known for years. The issue is how to unlock the value of a discount in most cases. The wikipedia link attempts to address the issue of premiums.</p>
<p>Keep in mind that EMT, as interpreted by most folks, does not say that every security will be priced "rationallY (whatever that means!) all the time. Rather, it is the efforts of millions of investors to find opportunity for abnormal returns that continually drives the market, and the price of each individual security to equilibrium. EMT in most forms also is interpreted to say that these efforts to find imperfections have a cost, be it trading costs, information costs, etc. that will ultimately equal the premium to be earned.</p>
<p>On the last note, it might be interesting for you to look at some of the work done in the 1970s that looked at things such as filter rules. Filter rules worked in giving abnormal returns as long as transaction costs were zero. But they were not then (and were a lot higher than now), and these transaction costs ate up those potential abnormal returns.</p>
<p>It is so easy to find so called exceptions to EMT. But the difficulty is to find exceptions that provide the opportunity to earn abnormal returns. the wiki article was stuck on this point.</p>
<p>Northwestern has also taken note. He's a pretty cool dude, even if he did spend the bulk of his career Over There:</p>
<p>As we all know, Kellogg is a terrible school. South Siders just have more fun, and won't let go on a chance to increase the already questionable Nobel Prize count! :-P</p>
<p>newmassdad,</p>
<p>But that's my point. In the late 90's, you could pick up a 10K for an internet firm, and still not be able to figure out why it was valued at 400x earnings. It was irrational exuberance that resulted in these high stock quotes, not real book value. This is where behavioral finance comes in. The 90's were a period of great opportunity for those who realized that prices were absurdly high, just as the early 2000s were a time of opportunity for behavioral finance adherents who realized that prices were too low after the tech crash. </p>
<p>Purchasing CEFs at a high discount when VIX is high is a proven long term strategy (that is used in practice: at Merrill Lynch PBIG they use it every day).</p>
<p>oh my god finance talk</p>
<p>hey did you guys check the markets lately? is the firm's performance optimized? benchmarks down jones assets capital budgets shares markets firms HEDGE FUNDS oh my god get a life</p>
<p>CB, </p>
<p>The problem with behavioural finance, at least with your example, is that no one knew when the high was. I personally recall well some proponents of irrational exuberance that called the high long before it was reached, such that if a trader believed that data, they would have lost money compared to a buy and hold strategy. </p>
<p>It is easy to use behavioral finance to explain past actions and much harder to use it to make money looking forward. </p>
<p>BTW, if you like behavioral finance, you might enjoy some of the work done by Daniel Kahneman, especially some of his early work with Amos Tversky. They published a wonderful paper in Science about heuristic (although I don't think it was called by that term then) and biases in reasoning about probability among people.</p>