Alan Dix Snip!t: The Nobel Prize in Economics 2013: of the madness and the wisdom of crowds

Snip summary	Investors’ behaviour on stock markets has been likened... irrationality described in Charles Mackay’s 1841 class... Popular Delusions and the Madness of Crowds. But there i... positive view of what crowds can achieve. In his 2005 bo... Fama’s wo The Nobel Prize in Economics 2013: of the madness and the wisdom of crowds \| OECD Insights Blog http://oecdinsights.org/...onomics-2013-of-the-madness-and-the-wisdom-of-crowds/

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Investors’ behaviour on stock markets has been likened... irrationality described in Charles Mackay’s 1841 class... Popular Delusions and the Madness of Crowds. But there i... positive view of what crowds can achieve. In his 2005 bo...
Fama’s wo

The Nobel Prize in Economics 2013: of the madness and the wisdom of crowds | OECD Insights Blog: http://oecdinsights.org/...onomics-2013-of-the-madness-and-the-wisdom-of-crowds/

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Investors’ behaviour on stock markets has been likened to the irrationality described in Charles Mackay’s 1841 classic Extraordinary Popular Delusions and the Madness of Crowds. But there is also a more positive view of what crowds can achieve. In his 2005 book The Wisdom of Crowds, James Surowiecki argued that “diversity and independence are important because the best collective decisions are the product of disagreement and contest, not consensus or compromise.” Diversity and disagreement certainly characterise this year’s Nobel prize for economics, even if Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller shared the award “for their empirical analysis of asset prices”.

Fama’s work is based on the idea that asset returns should be impossible to predict if asset prices reflect all relevant information. He tested empirically (and found new methods like event studies to do so) the efficient markets hypothesis (EMH), for which he and his followers found ample evidence. That is, in the very short run, like a day or a week, if all available information is incorporated in share prices, you cannot beat the market. While he accepts that there are factors like information or transaction costs that weaken the pure EMH, any anomalies – like the difference between value and growth stocks he analysed in a 1998 paper – are explained within the same rational investor framework, and risk factors would account for the differences. However, such anomalies (or “market imperfections”) may open up short-run arbitrage opportunities (that Fama himself exploits in his fund-management firm). Hedge funds and algorithmic traders in particular thrive on these imperfections.

HTML	<p>Investors’ behaviour on stock markets has been likened to the irrationality described in Charles Mackay’s 1841 classic <i>Extraordinary Popular Delusions and the Madness of Crowds</i>. But there is also a more positive view of what crowds can achieve. In his 2005 book <i><a href="http://www.randomhouse.com/features/wisdomofcrowds/" onclick="javascript:_gaq.push(['_trackEvent','outbound-article','http://www.randomhouse.com']);">The Wisdom of Crowds</a></i>, James Surowiecki  argued that “diversity and independence are important because the best collective decisions are the product of disagreement and contest, not consensus or compromise.” Diversity and disagreement certainly characterise this year’s Nobel prize for economics, even if Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller shared the award “for their empirical analysis of asset prices”.</p> <p>Fama’s work is based on the idea that asset returns should be impossible to predict if asset prices reflect all relevant information. He tested empirically (and found new methods like event studies to do so) the efficient markets hypothesis (EMH), for which he and his followers found ample evidence. That is, in the very short run, like a day or a week, if all available information is incorporated in share prices, you cannot beat the market. While <a href="http://www.jstor.org/stable/2328565" onclick="javascript:_gaq.push(['_trackEvent','outbound-article','http://www.jstor.org']);">he accepts</a> that there are factors like information or transaction costs that weaken the pure  EMH, any anomalies – like the difference between value and growth stocks he analysed in a <a href="http://www.jstor.org/stable/117458" onclick="javascript:_gaq.push(['_trackEvent','outbound-article','http://www.jstor.org']);">1998 paper</a> – are explained within the same rational investor framework, and risk factors would account for the differences. However, such anomalies (or “market imperfections”) may open up short-run arbitrage opportunities (that Fama himself exploits in his fund-management firm). Hedge funds and algorithmic traders in particular thrive on these imperfections.</p>

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Investors’ behaviour on stock markets has been likened to the irrationality described in Charles Mackay’s 1841 classic Extraordinary Popular Delusions and the Madness of Crowds. But there is also a more positive view of what crowds can achieve. In his 2005 book <a href="http://www.randomhouse.com/features/wisdomofcrowds/" onclick="javascript:_gaq.push(['_trackEvent','outbound-article','http://www.randomhouse.com']);">The Wisdom of Crowds</a>, James Surowiecki  argued that “diversity and independence are important because the best collective decisions are the product of disagreement and contest, not consensus or compromise.” Diversity and disagreement certainly characterise this year’s Nobel prize for economics, even if Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller shared the award “for their empirical analysis of asset prices”. Fama’s work is based on the idea that asset returns should be impossible to predict if asset prices reflect all relevant information. He tested empirically (and found new methods like event studies to do so) the efficient markets hypothesis (EMH), for which he and his followers found ample evidence. That is, in the very short run, like a day or a week, if all available information is incorporated in share prices, you cannot beat the market. While <a href="http://www.jstor.org/stable/2328565" onclick="javascript:_gaq.push(['_trackEvent','outbound-article','http://www.jstor.org']);">he accepts</a> that there are factors like information or transaction costs that weaken the pure  EMH, any anomalies – like the difference between value and growth stocks he analysed in a <a href="http://www.jstor.org/stable/117458" onclick="javascript:_gaq.push(['_trackEvent','outbound-article','http://www.jstor.org']);">1998 paper</a> – are explained within the same rational investor framework, and risk factors would account for the differences. However, such anomalies (or “market imperfections”) may open up short-run arbitrage opportunities (that Fama himself exploits in his fund-management firm). Hedge funds and algorithmic traders in particular thrive on these imperfections.

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