Economics●●●●●Difficulty 5 of 5

If prices already reflect everything we know, can anyone really beat the stock market?

In 2013 the Nobel Prize in economics went jointly to the man who said markets are efficient and to the man who said they are not.

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Mostly not, and not reliably, according to the efficient-market hypothesis. It says asset prices already reflect all available information. If news about a company is public, traders who act on it push the price until the news is no longer useful. So consistently beating the market, once you account for risk, should be impossible: prices only move on new information, which by definition nobody can know in advance.

The evidence is a mix. As early as the 1930s, studies suggested professional investors generally couldn't outperform the market, and short-term stock prices behaved like a random walk. That is why even Warren Buffett, a critic of the theory, recommends low-cost index funds for most people.

But the strongest versions of the idea don't hold up. Some kinds of stocks earned unusually high returns for long periods. Robert Shiller showed that prices swing far more than any rational forecast of future dividends could justify, and he warned of a stock bubble in March 2000, right at the peak. And there is a logical puzzle: if prices already contained all information, nobody would be paid to dig up information, so a perfectly efficient market couldn't exist.

The debate is so finely balanced that in 2013 the Nobel Prize went jointly to Eugene Fama, the theory's champion, and to Shiller, its most famous critic.

Two Nobel laureates, two views of the market

Eugene Fama

  • Prices reflect all available information
  • Returns can't be beaten consistently after risk
  • Said the theory held up in the 2008 crisis

Robert Shiller

  • Prices swing more than rational forecasts justify
  • Bubbles happen: warned of one in March 2000
  • Human psychology moves markets
Eugene Fama, an older man in a dark suit, speaking at a press conference table with a microphone.
Eugene Fama at the 2013 Nobel laureates' press conference in Stockholm, where he shared the prize with Robert Shiller and Lars Peter Hansen.Photo: Bengt Nyman · CC BY 2.0

Quiz me

0/3

  1. 1.Why, according to the theory, can't you consistently profit from public news about a company?
  2. 2.What is the "joint hypothesis problem"?
  3. 3.What does the Grossman–Stiglitz paradox say?

Recap

Very efficient, never perfectly: if prices held all information, nobody would be paid to find it.

Surprising fact · The theory's champion, Eugene Fama, and its best-known critic, Robert Shiller, shared the same Nobel Prize in 2013.

Sources (4)

No source, no claim. Every fact in this lesson (32 claims) cites at least one of these.

  1. [1]Efficient-market hypothesis · Wikipedia
  2. [2]Robert J. Shiller · Wikipedia
  3. [3]Grossman–Stiglitz paradox · Wikipedia
  4. [4]Index fund · Wikipedia
More lessons in 💰 Economics (3) See all economics lessons →

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