Typography

When I think of senseless waste, I think of the Battle of the Somme. Whole generations lost in order to move a trench line forward by a metre or two. Zoom forward in time to the modern finance industry which, for many decades, has been marshaling starry-eyed recruits in search of excess returns. I worry that all their effort has been wasted because, like the Somme's trenches, the integrity of prices can't be advanced any further once large amounts of effort are already being expended in beating the market. Fund managers who want to beat the market must find unique information in order to get a leg up on their competitors. But the supply of such information is limited so that at some point, prices include pretty much everything there is to know about a company. Any additional effort to hunt down information is wasteful from a society-wide perspective. The recent- ish phenomena of indexing gives us a feel for how far beyond the 'waste point' we've gone. Rather than tr...

 The "High minus low" strategy: Source   If you haven't read Clifford Asness and John Liew's recent article on market efficiency, you should. There's plenty of meat in the article, but the one sinew I want to chew on is this above chart.  It shows the cumulative returns to a strategy called HML , or "high-minus-low." This strategy involves going long cheap U.S. stocks (as measured by their price-to-book ratio) and simultaneously going short expensive stocks. Over the last eighty-five years or so, cheap stocks have roundly beat out expensive ones. This is called the value premium . A large part of Asness and Liew's investing effort revolves around exploiting this premium for their clients at AQR Capital Management . Now as the authors point out, this outperformance could be due to a combination of two things. The behavioural explanation is that people are irrational, subject to various psychological tics that drive aberrations in prices. Perhaps inv...

Tomorrow marks the twenty-sixth anniversary of the 1987 stock market crash. On October 19, 1987 the Dow Jones Industrial Average fell 22.6%, the largest one-day decline in stock market history. The best explanation for the decline, and the least well-known one, was put forth by economist Robert Shiller. This post gives a quick rundown of Shiller's work on understanding crash phenomena, in particular the famous 1987 event. Eugene Fama, who along with Shiller and Lars Hansen shared the Nobel Prize this week, had very different reaction to the event than Shiller. In an essay penned not long after the crash, Fama, a true believer in the efficient market hypothesis, did his best to square the event with theory. The crash, wrote Fama, has the look of an adjustment to a change in fundamental values. In this view, the market moved with breathtaking quickness to its new equilibrium, and its performance during this period of hyperactive trading is to be applauded. [Perspectives on October 1...

The following quote is a great expression of the efficient market hypothesis : ...the bulk of the statistics which the fundamentalists study are past history, already out of date and sterile, because the market is not interested in the past or even in the present! It is constantly looking ahead, attempting to discount future developments, weighing and balancing all the estimates and guesses of hundreds of investors who look into the future from different points of view and through glasses of many different hues. In brief, the going price, as established by the market itself, comprehends all the fundamental information which the statistical analyst can hope to learn (plus some that is perhaps secret from him, known only to a few insiders) and much else besides of equal or even greater importance. So who wrote these words? Fama, Malkiel, or Samuelson? Funny enough, I've pulled this quote from The Technical Analysis of Stock Trends by Robert Edwards and John Magee, the so-called bibl...