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View Diary: Nobel Prize for Economics = neo-liberal swinefest UPDATED (197 comments)

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  •  Gah... whether or not you can use the word (0+ / 0-)

    "optimal" to describe the prices Fama predicts, the term is not used in that sense in that area of science.

    The efficient-market hypothesis revolves around the idea that the price set by the market is, in fact, the best possible estimate of what the price "should" be -- meaning, more or less, a reasonable estimate of what the price is going to be in ten minutes -- given all of the available information and human understanding of that information.
    Well, that's self obviously true.  For example, Apple closed at 504.50 today.  I will happily bet you that it will open tomorrow within 10% of that.  Asset prices are "sticky".

    A more complicated question is whether Apple's past price movements tell me anything about whether Apple will open higher or lower tomorrow than it closed today.  That's a much more interesting question.

    Short answer:
    1. Beta is sticky - it does not change over relatively long periods of time.
    2. Expected return based on risk free rate, beta, and market premium is sticky as well.  (Actually, should use Fama French 3 factor model, but I'm trying to keep this simple.)
    3. Fluctuations around the expected return are totally unpredictable

    This is what Fama got his prize for.

    This is, without doubt, an "optimization problem", of the sort typically associated with machine learning algorithms that apply to dynamical systems.
    Well, it's got nothing to do with machine learning algorithms - in fact, Fama's work can be applied to argue that no such algorithm can beat the market.

    As for an optimization problem, well, here's the definition of Optimization: "optimization includes finding "best available" values of some objective function given a defined domain".  This is not what Fama's work is about.

    You can apply optimization together with Fama's work - for example, finding the set of securities with the best expected risk adjusted rate of return, taking into account trading costs, for your mutual fund, but that's not what Fama studies.

    You take pride in taking his advice and making money by buying index funds. And indeed, this is a foolproof way to make money, in a rising market. Maybe, mind you, not a hell of a lot of money, depending on what else is going on around you. It is also a foolproof way to lose money, in a declining market.
    I don't take any particular pride - investing in index funds is as easy as falling off a log.  But I'm glad I did it.

    I agree, in a rising market index funds do well, and in a falling market they do badly.  Key point is that stock pickers have the same problem... except that they have more idiosyncratic risk and higher fees.  That's what you get out of Fama's research.

    •  The term "optimal" is used in exactly that (1+ / 0-)
      Recommended by:
      Sandino

      way in that kind of mathematical and computer science, which is what the economists at least purport to be doing.

      I do not claim that Fama's work is about finding optimization schemes for "beating" the markets. As you note to the contrary, his strongest claim is that such schemes are generally doomed.

      But Fama's reason for claiming that they are doomed is that he believes the market itself is executing an optimization algorithm that works better than any other possible algorithm.

      I strongly believe that Fama is very, very wrong about that -- in particular, all of my experience with such systems indicates to me that the market's inherent algorithm can't possibly be doing even a very good job of solving this particular optimization problem.

      Similarly, I believe that the entire "wisdom of the crowd" movement is:

      A. Wrong
      and
      B. Motivated primarily by a dogma that rests on wishful thinking and a sad combination of libertarian idealism and inane anti-elitism.

      To put the torture behind us is, inevitably, to put it in front of us.

      by UntimelyRippd on Thu Oct 17, 2013 at 08:01:42 PM PDT

      [ Parent ]

      •  An optimization algorithm to solve precisely what (0+ / 0-)

        problem?

        But Fama's reason for claiming that they are doomed is that he believes the market itself is executing an optimization algorithm that works better than any other possible algorithm.
        The market sets prices, but it's not an optimization algorithm in the usual sense of the word.
        I strongly believe that Fama is very, very wrong about that -- in particular, all of my experience with such systems indicates to me that the market's inherent algorithm can't possibly be doing even a very good job of solving this particular optimization problem.
        Can you back that up with anything more than a theory?

        How about an algorithm that beats the market?  We can start a hedge fund together, become .00001 percenters, and run for office as Republicans.

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