Economists Do It With Models

Warning: “graphic” content…

Bookmark and Share
When The Efficient-Markets Hypothesis Gets Taken Too Far, With Bonus Zoo Footage…

June 8th, 2014 · 6 Comments
Finance

It’s no secret that many economists believe in the efficiency of markets- in fact, there’s a fairly well-known joke that goes something like the following:

Normal person: Hey look, somebody dropped $20 on the sidewalk.
Economist: Nonsense- that can’t be a real $20 bill, since, if it was, somebody would have picked it up already.

More generally, one feature of efficient markets is that all transactions that are profitable for all parties involved actually happen. This, however, doesn’t mean that no one can profit in an efficient market (which is why the economist in the joke’s logic is absurd), it just means that profit opportunities aren’t left on the table indefinitely in an efficient market.

The efficient-markets hypothesis puts a bit more structure on this concept, especially as it relates to financial markets (i.e. markets for stocks, bonds, etc.). The efficient-markets hypothesis, at its core, suggests that asset prices are “correct” in that they properly and rationally reflect all available information. This feature of efficient markets, according to economists, occurs precisely because market participants quickly take advantage of all of the ways to profit from asset mispricings, and these actions bring prices to their proper levels.

In another context, then, the efficient-markets hypothesis taken to the absurd extreme gets us this:

Full disclosure: I helped with this one, so you should probably blame me if you don’t like it. Also, my economist friends and I found a $10 bill on the ground at the zoo last week, and we actually picked it up- good thing I’m a behavioral economist, otherwise I might worry that my economist membership card would get taken away. (Then again, we did have a longer than reasonable conversation about how we should split the $10, so perhaps not.)

In related zoo news, economists understand the value of scarcity as it pertains to animals:

Also, I need this sign for my office…

…mainly because it would mean I get to research the economics of pandas.

Tags: Finance

6 responses so far ↓

  • 1 Brett // Jun 8, 2014 at 7:59 pm

    That’s really something the EMH people ought to put more weight on – what it means for the market to “quickly” clear. Especially since there’s the valid point from Keynes that the market can stay “irrational” longer than you can stay solvent, something that especially pops up in the labor market.

  • 2 J. Edgar Mihelic // Jun 9, 2014 at 3:30 pm

    “(i.e. markets for sticks, bonds, etc.).”

    Sticks for sale…….Get your sticks here……

  • 3 Jeff Johnson // Jun 10, 2014 at 4:41 am

    @j. Edgar
    Have you tried selling carrots? I hear they’re more in demand.

  • 4 Jeff // Jun 10, 2014 at 6:34 pm

    Brett – something else that pops up most frequently in the labor market is a “V”-shaped supply curve. People work the harder when they are greedy or desperate, and yet labor supply and demand is frequently modeled assuming that people are always greedy and never desperate. The funny thing is, if you allow for desperation, some of the oddities of the Great Depression fall out of the math with just a few steps.

  • 5 econgirl // Jun 11, 2014 at 12:24 am

    @J. Edgar: I knew I kept you around for a reason. :)

  • 6 The absurd efficient market hypothesis | What is behavioral? // Jun 17, 2014 at 8:33 am

    [...] When The Efficient-Markets Hypothesis Gets Taken Too Far, With Bonus Zoo Footage… [...]

Leave a Comment