Comment by doghead on Asset Prices Consistently Violate Efficient Market Hypothesis · 2020-07-31T21:02:14.212Z · LW · GW

I don’t think this summary does a sufficient job of capturing the nuance of the argument being put forth. It also might be giving the impression that the critique is based on a misunderstanding of EMH, which his first paragraph well states. The author is directly claiming there is a clear mis-pricing in assets that offer a greater than total market risk-adjusted return. It is one thing to claim he is talking his book, which he is, it is quite another to ascribe ignorance to the view articulated without reckoning with any of the arguments.

Momentum as a factor is hard to explain under EMH because if the current price incorporates all known information, how can the time series of price information contain a trade-able edge?

The example of HKL is put forward, which is a holding company for prime real estate in Hong Kong and Singapore. The stock trades at valuation of only 25% of the most recent market value of their net real estate holdings. There are many possible reasons for this, and it is fairly common for holding companies to trade at a discount to their net assets. The author argues this is due to an anchoring type effect. The shares of HKL are traded on an exchange among other stocks. The salient benchmark being the rates of return of the rest of the equities in the market. To match the higher yields available from other equities HKL must trade at a discount to book.

The underlying real estate assets are being valued differently on the open market. Here a 4% yield looks great if the salient benchmark is fixed income, which is reasonable because of the high quality of the cash flow. If both of these are true the same asset is being valued differently based on the market it is being traded in. This not only violates EMH, but also the law of one price. This is an arbitrage opportunity but the onus is on a market participant to articulate and execute the trade that captures this opportunity.

Crucially he is not arguing the market is not incorporating public knowledge efficiently. The argument states there are principle-agent problems writ large in financial markets the allow for persistent mis-pricing of assets. To capture these opportunities you don’t need better knowledge but a better structure than the average market participant.

Whether EMH is true or not, it seems to get a lot of free credit as a theory. It proves so little and commits its adherents to so much. I think its popularity may lie more in its beauty than in its truth.