BLACK MONDAY, BLUE MONDAY, THE EMH, AND ALL THAT
As I sit here listening to the umpteenth talking head . . . er, market expert . . . pontificate on the whys and wherefores of "Blue Monday" - the 554-point drop in the DJIA on October 27, 1997 - I am reminded of the following item from a column in a recent issue of Fortune magazine:
"Popular delusion three: Markets are efficient. The efficient market hypothesis, or EMH, would do credit to medieval alchemists and is about as scientific as their efforts to turn base metals into gold."
The column's writer, a well-known investment advisor, clearly is not convinced by the volume of empirical evidence generally supporting the EMH. Now consider one more quote:
"Popular delusion four: Market timers can stack up superior returns, selling when stocks look high, buying back in when stocks look cheap. The truth is nobody can consistently predict the ups and downs of the market." (emphasis added)
Apparently the person who wrote the latter is in agreement with at least one of the major implications of the EMH. Which writer is correct? The same person wrote them both, and in the same article! So much for the experts!
In discussing with your class the 508-point Crash of October '87 ("Black Monday"), the 554-point mini-crash of October '97 ("Blue Monday"), and the next day's 350-point rebound ("make up your own name"), it is my guess that some students will question the validity of the EMH. (As a matter of fact, I have 20 bucks that says an article will appear on the editorial page of The Wall Street Journal sometime in the next few weeks declaring that the "EMH is Dead!")
How you interpret the empirical and anecdotal evidence is up to you, but here is how I characterize this type of thing for my students:
1. The EMH doesn't imply that all stocks are all priced efficiently all of the time; rather, it implies that, market prices are good estimates of economic value on average.
2. If you want anecdotal evidence of the EMH, consider the fact that virtually all of the pundits were taken by surprise by Blue Monday (as well as by Black Monday ten years earlier); the short-term ups and downs of the market have proven once again to be unpredictable; and that this is entirely consistent in a market which is informationally efficient, at least to the semistrong level.
3. Those who contend that "the evidence" of current events contradicts the EMH are duty-bound to propose (and test) an alternative hypothesis. Don't hold your breath.
What do you think? Is the EMH dead? Let me know!
RWJ Teaching Tips Archives Adopter Resource Page
If you have a question or a problem about a specific book or product, please fill out our Product Feedback Form.
For further information about this site contact mhhe_webmaster@mcgraw-hill.com
or let us know what you think by filling out our Site Survey.
