The Efficient Market Hypothesis Lie
The Efficient Market Hypothesis (EMH) states that all public (and maybe all private) information about an asset is already reflected in its price, making it impossible to consistently ‘beat the market’ since asset prices only react to new information.
If EMH is true, then it is impossible to predict stock prices, and you should probably be a passive investor (buying index funds). I used to believe that EMH was entirely accurate, but now I consider it a damn lie. Consider this thought experiment:
- Premise 1: The Efficient Market Hypothesis (EMH) is true.
- Premise 2: All investors believe that Premise 1 is true.
- Conclusion 1: Therefore, no investor makes fundamental or technical analyses, believing all public (and possibly private) information is already priced in, and instead, they adopt a passive investment strategy.
- Premise 3: Given Conclusion 1, a new investor who does not believe Premise 1 engages in technical or fundamental analysis and discovers investment opportunities, as this is the first time anyone else has done that analysis.
- Conclusion 2: Given Premise 3, Premise 1 is false because the new investor’s analysis leads to profitable opportunities, indicating that not all information was reflected in stock prices.
- Premise 4: A proposition cannot simultaneously be true and false (Law of Non-Contradiction).
- Conclusion 3: Therefore, Premise 1 (The EMH is true) is false.
This scenario is described as the “Grossman-Stiglitz Paradox” In other words, it argues that if markets were perfectly efficient and prices fully reflected all available information, there would be no incentive for traders to acquire costly information. Without the incentive to gather information, prices would not, in fact, reflect all available information, leading to market inefficiency. This creates a paradox where markets cannot be perfectly efficient.
A better way to reconcile this theory might be:
💡 The market is very, but not perfectly, efficient. It is very hard but still possible to beat the market.
You may think this slight adjustment wouldn’t categorize this theory as a lie. But this slight adjustment can drastically change your behavior. See some comments about the EMH:
the efficient market hypothesis is interesting not only because it’s widely believed and obviously untrue, but also because it becomes more untrue the more people act as if it were true.
The efficient market hypothesis is a lie
- At best it is a very lossy heuristic
- The best things in life occur where EMH is wrong
- In many cases it’s more accurate to model the world as 500 people than 8 billion
- “Most people are other people”
almost no markets fully satisfy the conditions of the EMH, and many important markets—like housing or prediction markets—strongly violate them.
And finally
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