Fama's EMH takes some hits
August 5th 2007 09:47
The column wrote by the veteran Singapore journalist, Seah Chiang Nee, would have made some behaviorial finance researchers and trend traders, a smile on their face, as a sign that the efficient market hypothesis (EMH) got a beating, even though the column did not carry any academic weight and evidence.
Nonetheless, the story reveal that even in a developed market such as Singapore, investor sentiment took a big swing without regards to fundamentals. In other words, stock prices and investor reaction should not have been so drastic under the EMH because the fundamentals remain solid. But it seems that investors react to the slightest market information irregardless of its relevancy to the shares they have interest in it. Likewise, the same for the global markets swing recently.
Mr. Seah writes:
"Lured by promise of easy money, thousands of students, young professionals, housewives and retirees have signed up trading accounts, pushing prices from one record to another.
Last week, the dizzying ride came to an abrupt end. In just a few days, the long expected market collapse wiped out much of the past gains – and then some.
It was a painful lesson to people who had believed that share trading was like playing in a casino.
Thousands put bets in a market that had overrun its fundamentals. Even a warning by the Monetary Authority of Singapore (MAS) failed to slow them down.
“Everybody knew a fall was imminent but told himself he would first make a killing before crisis hit,” an analyst said. They were playing the odds.
Visit any brokerage and you’ll likely encounter a group of men and women, many speaking Singlish or dialect, making bets as though they were sitting around a roulette table.
The wet-behind-the-ear newcomers buy shares on hearsay, gambling on companies without even knowing what business they are in or their profit records. They listen to “tips” from brokers or friends.
[...]
“I need to top up by S$40,000 (RM92,000) in the next few days and only have S$2,000 (RM4,600) in the bank,” said someone who borrowed to buy shares as he watched their values plunged by the hour.
“They’ll probably force sell some shares to pay for others. I’ve lost much of my savings.”
Another said he had lost S$30,000 (RM69,000) in one day, and a worker bemoaned about losing four months of his salary. “Where can I get a temporary loan, just need S$10,000 (RM23,000),” a blogger asked.
More than half the people polled in an online survey said they had lost money in what was – until this week – a record bull run.
Speculation, another name for gambling in stocks, accounts for the bulk of stock trading. During the recent fever, an old timer told me, “We don’t need a casino. We have the stock market.”
From the accounts above, lets ask Mr. Eugene Fama, the father of EMH,three questions on the three assumptions that form the bedrock of the hypothesis:
1) Are investors really rational in valuing securities as assumed?
2) Will trades by irrational investors cancel each other out and thus stabalise stock price?
3) What happened to rational arbitrageurs to eliminate the irrational trades?
Of course, to be fair, that the benefit of the doubt should be allowed because the accounts above could be just a small subset of the wider investment community which is tend to be dominated by the professionals. Yet, you wonder that with the general volatility, EMH doesn't really makes sense.
While the bulls and bears fight it out in the market, Fama and the likes from the behavioral finance camp will be warring out through journals.
Nonetheless, the story reveal that even in a developed market such as Singapore, investor sentiment took a big swing without regards to fundamentals. In other words, stock prices and investor reaction should not have been so drastic under the EMH because the fundamentals remain solid. But it seems that investors react to the slightest market information irregardless of its relevancy to the shares they have interest in it. Likewise, the same for the global markets swing recently.
Mr. Seah writes:
"Lured by promise of easy money, thousands of students, young professionals, housewives and retirees have signed up trading accounts, pushing prices from one record to another.
Last week, the dizzying ride came to an abrupt end. In just a few days, the long expected market collapse wiped out much of the past gains – and then some.
It was a painful lesson to people who had believed that share trading was like playing in a casino.
Thousands put bets in a market that had overrun its fundamentals. Even a warning by the Monetary Authority of Singapore (MAS) failed to slow them down.
“Everybody knew a fall was imminent but told himself he would first make a killing before crisis hit,” an analyst said. They were playing the odds.
Visit any brokerage and you’ll likely encounter a group of men and women, many speaking Singlish or dialect, making bets as though they were sitting around a roulette table.
The wet-behind-the-ear newcomers buy shares on hearsay, gambling on companies without even knowing what business they are in or their profit records. They listen to “tips” from brokers or friends.
[...]
“I need to top up by S$40,000 (RM92,000) in the next few days and only have S$2,000 (RM4,600) in the bank,” said someone who borrowed to buy shares as he watched their values plunged by the hour.
“They’ll probably force sell some shares to pay for others. I’ve lost much of my savings.”
Another said he had lost S$30,000 (RM69,000) in one day, and a worker bemoaned about losing four months of his salary. “Where can I get a temporary loan, just need S$10,000 (RM23,000),” a blogger asked.
More than half the people polled in an online survey said they had lost money in what was – until this week – a record bull run.
Speculation, another name for gambling in stocks, accounts for the bulk of stock trading. During the recent fever, an old timer told me, “We don’t need a casino. We have the stock market.”
From the accounts above, lets ask Mr. Eugene Fama, the father of EMH,three questions on the three assumptions that form the bedrock of the hypothesis:
1) Are investors really rational in valuing securities as assumed?
2) Will trades by irrational investors cancel each other out and thus stabalise stock price?
3) What happened to rational arbitrageurs to eliminate the irrational trades?
Of course, to be fair, that the benefit of the doubt should be allowed because the accounts above could be just a small subset of the wider investment community which is tend to be dominated by the professionals. Yet, you wonder that with the general volatility, EMH doesn't really makes sense.
While the bulls and bears fight it out in the market, Fama and the likes from the behavioral finance camp will be warring out through journals.
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