Efficient Market Hypothesis: The Meltdown’s Biggest Casualty

Question: You are a critic of the Efficient Market Hypothesis, calling it the biggest casualty of the crisis. Why?

Chrystia Freeland: In academic circles and on Wall Street, the Efficient Market Hypothesis has long been viewed with a lot of skepticism, or at least as a useful theoretical construct in some ways, but certainly not the definitive answer to everything.  So, I think it's not news for anyone that market players are not all perfectly rational, that markets are not perfectly efficient, that arbitragers do not in all circumstances arbitrage away mispricing.  Economists have been writing about this for a really long time.  Financial economists have as well.  There's a famous and really important paper by Andre Schwifer that was written before the Tech Bubble making this argument about how bubbles actually are endemic to the markets.  There's been some recent writing again, before this crisis, by a fabulous economist called Marcus Brunemeier at Princeton, where he makes the argument, backed by both empirical data and by some mathematical reasoning which says that actually it is in the interests of hedge funds to buy into a bubble rather than to bet against it. That's a really, really important point because so much of our thinking, and now I'm speaking not about our thinking in ivory tower, or our thinking of the smartest of hedge funds where people have known this.  I mean hedge fund managers have been buying into a bubble for decades, maybe for centuries.  But so much of our conventional wisdom thinking, and a conventional wisdom which I think had a great impact on policy, was that markets would take care of themselves.  And this was probably most eloquently and authoritatively this point of view was advanced by the U.S. Fed, and by Allen Greenspan, who was a wonderful advocate of this point of view, really eloquent, really persuasive.  And he has now slightly recanted it in the immediate wake of the crisis.  He said, "Actually, I'm so surprised and really so," he uses the word shocked, "that market players turned out not to be able to take care of their own interests."  To me, that is the big intellectual lesson of this crisis.  That what is in the interests of individual players and the individual players pursuing their individual interests collectively will not always create an outcome which is good for the collective or even for those individual players. And therefore you need someone in the center, an umpire, or a referee, whatever you want to call that person, to hold the ring and to care about the collective outcome. 

What I think is important in this way of thinking is to realize that having that umpire is good for everyone, even for the individual players.  And that's not a new intellectual concept.  There's lots of writing about what's called the tragedy of the commons.  And there are lots of other social and economic situations in which we've understood that if we let everyone pursue their own self-interests without having any rules, it's not going to work.  The fact that we have traffic laws is maybe the most obvious retail example of that.  I think we need to think about that more seriously when we are talking about financial markets. 

Recorded on December 7, 2009

The takeaway of the crisis: individual players pursuing individual interests collectively will not always create an outcome which is good for the collective or even for those individual players, says Chrystia Freeland, U.S. Managing Editor of the Financial Times.

The 10 most influential women in tech right now

These thought leaders, founders, and entrepreneurs are propelling the kind of future we want to be a part of.

Credit: Flickr, The Wall Street Journal, TechCrunch
Technology & Innovation
  • The tech industry may be dominated by men in terms of numbers, but there are lots of brilliant women in leadership positions that are changing the landscape.
  • The women on this list are founders of companies dedicated to teaching girls to code, innovators in the fields of AI, VR, and machine learning, leading tech writers and podcasters, and CEOs of companies like YouTube and Project Include.
  • This list is by no means all-encompassing. There are many more influential women in tech that you should seek out and follow.

Keep reading Show less

Teen popularity linked to increased depression in adolescence, decreased depression in adulthood

The results of this study showed depressive symptoms being highest in adolescence, declining in early adulthood and then climbing back up again into one's early 30s.

Credit: Dragana Gordic on Shutterstock
Mind & Brain
  • A 2020 Michigan State University study examined the link between teen social networks and the levels of depression later in life.
  • This study used data from the National Longitudinal Study of Adolescent to Adult Health, specifically targeting social network data. The results showed depressive symptoms being highest in adolescence and declining in early adulthood, then climbing back up again into one's early 30s.
  • There are several ways you can attempt to stay active and socially connected while battling depression, according to experts.
Keep reading Show less

90,000-year-old human hybrid found in ancient cave

Researchers have just discovered the remains of a hybrid human.

Researchers in a chamber of the Denisova cave in Siberia, where the fossil of a Denisova 11 was discovered. CreditIAET SB RAS, Sergei Zelensky
Surprising Science

90,000 years ago, a young girl lived in a cave in the Altai mountains in southern Siberia. Her life was short; she died in her early teens, but she stands at a unique point in human evolution. She is the first known hybrid of two different kinds of ancient humans: the Neanderthals and the Denisovans.

Keep reading Show less

In quantum entanglement first, scientists link distant large objects

Physicists create quantum entanglement, making two distant objects behave as one.

Credit: Niels Bohr Institute
Surprising Science
  • Researchers accomplished quantum entanglement between a mechanical oscillator and a cloud of atoms.
  • The feat promises application in quantum communication and quantum sensors.
  • Quantum entanglement involves linking two objects, making them behave as one at a distance.
  • Keep reading Show less
    Quantcast