Saturday, January 20, 2007

EMH and noise

Tim Harford uses the queue analogy again to good effect to look at the EMH and noise trading.

In fact real people make systematic mistakes, not just random ones. That might ruin things in the supermarket, but not in the stock market. In the supermarket a group of elite queue “arbitrageurs”, trying to exploit different queue lengths, could not equalise queues when faced with hordes of ignorant shoppers who irrationally favoured aisles three and four.

In the stock market, when smart investors can take advantage of other people’s stupidity (for instance by buying cheap shares in December and offloading them in January) then these smart investors get richer and more influential. The irrational investors may be numerous but they will also be impoverished and inconsequential.

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