Saturday, February 6, 2010
Thoughts on Efficient Capital Markets A Review of Theory and Empirical Work by Eugene Fama - Earl Malvar
Based on Fama’s empirically-based findings, I believe that markets operate under an efficient market model. Although detractors may find exceptions through which to challenge the efficient market hypothesis, I think the points of contention arise more from the arguments of semantics and of how “all available information” is interpreted. Indeed, if it can be argued that some prominent investors have “success stories” to share, then this goes against how the market functions in “fully reflecting” the information that matter. Moreover, in recognizing the efficient market hypothesis, it is basically saying that active portfolio management becomes irrelevant. However, I think that information only matters to a price if it matters to those who concern themselves (people) with it. Price action in markets becomes the reality only if the valued information reaches the judgment of those who need to receive it. Big money may influence a price, but it does so because it keeps itself within the “area of awareness” for data or facts that may bring about price movements. A new investor looking at a stock, would initially be unengaged to the factors that matter for a certain stock’s price and may even nonchalantly put money on a stock simply because it is the market’s consensus price, but eventually he will become acquainted to the facts that matter. It may be something as philosophical as asking the question “Does a tree make a sound, if it falls in the forest and there’s no one around?” My sense is deviations of stock or portfolio performance is more about market timing based on insights. The market still reflects all available information, but those in the right position at the right time would eventually benefit from what the market does. Now, whether or not outcomes are due to pure luck or investor skill and astuteness may be difficult to say. Money influences money in financial markets and even if empirical studies have shown that big institutions cannot categorically do better in the market, they have more funds to sustain bids and offers than smaller market players who would otherwise be tapped-out. Anticipated information, data and facts indeed are ultimately priced in by market players. Whether or not only a few have a monopoly on very influential information is moot or even trivial in my opinion because eventually these facts will come out, they have to come out, in the open for all the market to evaluate, otherwise the existence of this price-moving factor would contradict itself. If a stock is illiquid and only two parties determine its market price through their bids and offers, then these two parties would basically be the market for this stock. Any exclusive information (that could push the price of a stock) possessed by one party can only be rendered valuable if the second party concurs. Ultimately, capital gains on the stock or bigger dividend payouts can only be benefited upon when the fact is reinforced by the stock’s company itself (also implying that facts have become public knowledge). Expanding this thought to a very dense capital market, however, brings-in so many factors into consideration, not to mention the practice of speculation, that it becomes inevitable for the few market players with good investment insight to be swept by the market belief or consensus. I think, however, that these insightful investors benefit from their unique market outlook or knowledge by positioning themselves better (whether in terms of timing or in amount invested) before the market catches up to the reality of it all. Whether it be called luck or wisdom, it may eventually be given judgment by the markets through time.