This page has been archived and commenting is disabled.

Guest Post: Everything You Know About Markets Is Wrong?

Tyler Durden's picture


Submitted by Eric L. Prentis,

The financial elite—using academe for intellectual cover—want you to believe that markets are efficient, as defined by the Efficient Market Theory (EMT). My research strikes down this hoary old EMT economic dogma, used by duplicitous bankers and hedge fund managers to con US politicians and 99% of Americans.

The Efficient Market Theory (EMT) is a significant foundation theory in economics. Prove the EMT wrong, and economics becomes largely an empty shell. Therefore, the EMT is the most important fundamental issue in economics and for America.

US politicians mistakenly use EMT based economic theories to pass laws favorable to Wall Street. First causing and now worsening the credit crisis. Examples of credit crisis enabling legislation include:

  • Gramm–Leach–Bliley Financial Services Modernization Act of 1999
  • Commodity Futures Modernization Act of 2000
  • Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
  • Jumpstart Our Business Startups (JOBS) Act of 2012

Three tenets define the EMT.

  • The first tenet—that markets are in equilibrium and if unexpected events cause disequilibrium, it is only temporary because markets are self-equilibrating—is disputed in the literature. A stock market always in equilibrium and efficient is impossible because traders have different endowments, beliefs and preferences. In addition, arbitrage costs throw markets out of equilibrium.
  • The second tenet—that stock prices “fully reflect” all information—has long been challenged in the literature, with many inconsistencies reported. Tenet number two goes on to say asset prices properly represent each asset’s intrinsic value, and as a result, prices are always accurate signals for capital allocation. Researchers in behavioral economics find fault with this EMT assumption, because it does not account for human nature and inherent herding behavioral instincts of market participants. EMT theorists—Eugene F. Fama and Burton G. Malkiel—claim assuming market equilibrium is close enough to reality, and that research into EMT tenet two contests only the semi-strong form of efficiency. That is, where earning higher returns than the stock market, with lower risk, is not achievable by knowing all publicly available information. EMT theorists continue to support the EMT and say, “If you want to do better than stock market returns, you have to take on more risk than the stock market.”
  • EMT tenet number three is most important—that is, stock prices move randomly or are uncorrelated with, if not independent of the prior period’s price change. Therefore, earning higher returns than the stock market, with lower risk, is impossible to achieve using only past prices (i.e., technical analysis stock trading rules or stock charts). Empirically prove EMT tenet number three wrong— because it tests the weak form of market efficiency—and the EMT is wrong, period!

EMT theorists specify two methods to test EMT tenet number three. The first method is statistical inference. Calculate serial correlation coefficients of stock price changes. If the serial correlation coefficients are zero or close to zero, this supports assuming serial independence in the price data. Therefore, one can infer that technical analysis stock trading rules cannot work. The second method requires using a technical analysis stock trading rule predictive model that forecasts the future, based solely on past prices—where expected profits are greater and risk lower than they would be under a naïve buy-and-hold policy.


Research that supports the EMT makes one-or-all of the following mistakes:

  • Using the wrong data—Systemic market risk and random unsystemic risk make up individual company stock price movements. As much as 50% of a company’s stock price actions are random unsystemic risk variations associated with the internal circumstances within that particular company. The remaining 50% of a company’s stock price movements represent the systemic risk of the overall market. The random unsystemic risk is the chaotic portion of the stock price data—that if removed leaves only the systemic market risk of the overall market, which may then be analyzed. Most EMT research studies day-to-day stock price movements of individual companies, which is mistaken. Granted, this unsystemic and systemic, day-to-day individual company data look random, but it is the wrong data to analyze to determine overall, long-term market trends.
  • Using the wrong method to analyze the data—Most researchers use statistical inference to test tenet number three. However, there is a serious problem with using statistical inference to test whether stock price data are independent. That is, it is difficult to distinguish between a rootless series and one where the systemic quality is faint. Research shows that five-thousand years of data are needed to identify independence in stock price data using statistical inference. However, these data do not exist. Consequently, statistical inference is not the correct method to use to test tenet number three.
  • Jumping to mistaken conclusions based on half-truths—Statistical inference tests using day-to-day individual company data report serial correlation coefficients that are close to zero. This supports assuming serial independence in the price data. Therefore, one can infer that tenet number three is valid. Unfortunately, this proves nothing of the sort. Analyzing the wrong data over an inadequate number of years simply gives a false positive.


What day-to-day stock price movements are for individual companies is the wrong research question. Instead, we want to know what the overall stock market is doing over the long term. The correct way to look at market data follows.


Using correct data—Individual company stock price behavior, which includes the randomness of unsystemic risk, is not evaluated. Instead, only systemic market risk is analyzed in my published journal research—please see here and here—by comparing only systemic market risk of two well-diversified S&P 500 Index portfolios. S&P 500 Index portfolio B is for active trading and S&P 500 Index portfolio A is the benchmark portfolio. Focusing only on systemic market risk in the data studied, removes much of the random or chance stock market price behavior of individual companies.

When investing over 1, 2, 3, 4, 5 years or more—day-to-day stock price movements are immaterial to trading success and may be thought of as just daily market chatter. Concentrating on daily price movements of individual company stock or the stock market as a whole is not the correct question. Day-to-day stock price action is volatile. To dampen out this daily chatter and give perspective to what is occurring long-term in the stock market, S&P 500 Index “monthly price data” are used to smooth out stock price volatility.

Monthly price data are important in dampening out day-to-day price movements. However, using last month’s price to predict next month’s price is also not conducive to long-term trend development. To further smooth price variations and focus on systemic stock market risk. Nine and two-month simple moving average (SMA) trend lines are fit to the S&P 500 Index monthly price data for actively managed portfolio B. Smoothing out data volatility, which gives an overall view of the long-term stock market trend. This is the third step in removing much of the random stock market price behavior from the research data.

Focusing only on systemic stock market risk in the monthly data and smoothing stock price volatility using nine and two-month SMA trend lines for the well-diversified S&P 500 Index portfolio B—to lessen random variations—is a major difference between my research and other EMT research in the literature, and a major reason the results are so significant.

My research covers 1871-through-2008, 138 years. All available Standard & Poor’s (S&P) 500 Index data are included in this research study, making it the longest duration and complete in the literature.


Using the correct method to analyze the data—Fama’s approved second method for testing the EMT, requires using technical analysis. Fama says to develop and test, over both good and bad economic conditions, a technical analysis stock trading rule predictive model that forecasts the future, based solely on past prices—where expected profits are greater and risk lower than they would be under a naïve buy-and-hold policy.

My empirical research method directly tests stock market price independence of EMT tenet number three, using a new technical analysis stock trading rule predictive model. To test whether expected profits are greater and risk lower than a benchmark naïve buy and hold policy, which Fama calls, “an equally valid scientific method versus statistical inference.”


Empirical results—In my US stock market research, the relative maxima and minima stock trading rule S&P 500 Index portfolio B—by $495,360 dollars (i.e., $580,423 - $85,063)—makes +582% more money than buy-and-hold S&P 500 Index portfolio A—and is only 64% as risky over 138 years—from January 1871 through December 31, 2008.


The new technical analysis relative maxima and minima stock trading rule predictive model makes substantially more money at significantly less risk than the naïve buy-and-hold policy. EMT theorists say this thorough beating of the US stock market should be impossible to achieve using only technical analysis. Thus, tenet number three and the weak form of the EMT are invalid, making the Efficient Market Theory wrong, period!



 Neoliberal economic philosophy, starting around 1980 and now mainstream in academe and American politics, promotes laissez-faire economic policies of reducing the size of government, deregulation and privatization of government services. Neoliberal economists base this philosophy on the belief that neoclassical economic theory is correct. That is, that “markets are efficient”—my research shows the EMT is dead wrong.

Gullible US politicians believe that markets are efficient and defer to them. Therefore, US politicians abdicate their responsibility to manage the overall economy, and happily for them, receive Wall Street money. Mistakenly, the primary focus during the 2008 credit crisis is on fixing the financial markets (Wall Street banks) and not the “real economy.” 

Wall Street touts markets as trustworthy and infallible, but that faith is misplaced. Big market players easily manipulate markets. For example, by changing accounting laws so banks no longer have to mark-to-market, High Frequency Trading (HFT) front running, and multinational companies buying back their common stock shares, along with favorable huckstering of stock positions on CNBC—owned by Comcast and General Electric. In addition, Chairman Bernanke, because of his Quantitative Easing II, takes credit for the Russell 2000 Index of small company stocks reaching an all-time high of 860.37.

The Federal Reserve (Fed) talks of added quantitative easing (QE), but this would mainly help the richest 1% of Americans and hurt the “real economy,” with higher gasoline and food price inflation. Unfortunately, QE only helps overinflate the stock and commodity markets by manipulating prices. Despite Fed programs QE I&II and Operation Twist, America is experiencing the worst economic recovery from a recession, ever! President Obama, if he wants to lose the 2012 election, will let Bernanke electronically print more QE money and make the “real economy” worse than it otherwise would be.

The continuing credit crisis is serious—with the world economy poised for a double-dip recession. The current US government policy of increasing the national debt by $5 trillion dollars over the past four years, keeping insolvent banks from going bankrupt, a Federal Reserve zero interest rate policy (ZIRP), causing malinvestment, and monetizing the national debt (which is what tin-pot dictators do just before they are forced to flee the country) with quantitative easing by the Fed, and austerity for the 99% to repay bad bank loans has not worked—and doing more of the same will not work—and defines insanity.


The financial elite are using this “cover-up and pray” policy—hoping that rekindled “animal spirits” will bring the economy back in time to save the status quo. This is impossible because the trust is gone. The same sociopaths control the economy. Instead, the financial elite are just protecting themselves with outlandish pay bonuses, based on cooked books; while the “real economy” flounders with high unemployment, unsustainable budget deficits, a struggling real estate market, and low capital formation, crumbling infrastructure and high gasoline and food price inflation.


Conclusion—this is what to do:

  1. Reenact the Glass-Steagall Act. Allowing investment banks to speculate with savers’ money is criminal.
  2. The daisy-chained, unregulated $707 trillion dollar OTC Derivatives market will bring down the world economy, when it goes bust. JP Morgan’s recent huge OTC Derivative trading losses are a prelude to this eventuality, with many more instances to come. Start unwinding the OTC Derivatives market now, before it is too late.
  3. Insolvent banks are a drain on the “real economy.” Force insolvent banks to go bankrupt. TBTF is an irrational policy. Allow capitalism to work for the 1%.
  4. Public and private debt to GDP is about 360%, and 30% of Americans are being hounded by bill collectors for unpaid debts. Americans can no longer service their massive debt loads. Allow debt forgiveness for the 99% and institute austerity for the 1%—they can afford it.
  5. ZIRP is destroying capital formation and savers. Allow interest rates to rise, which will increase consumer demand. The Fed’s manipulation of capital markets causes malinvestment—resulting in crippling long-term penalties for the “real economy.”

- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Tue, 06/12/2012 - 06:43 | 2517242 falak pema
falak pema's picture

lol, the answer lies in the question; to have a market you need a state, to run a state you need a process (election or chosen king), to exercise power in name of people you need laws and regulation. Its been that way since the dawn of time.

The only place on earth where markets existed without government was before man was sedentarised and money invented. We had no kings and we bartered and the tuff guy always won, including the loser's wife and children! You wanna go back there? I guess the only OTHER place would be in Heaven, where we would have perfect markets; but where there would be no need for them. As eternal sex would be free! And picture perfect!

Tue, 06/12/2012 - 06:37 | 2517196 falak pema
falak pema's picture

It is interesting to see ZH propose two guest posts here which are diametrically opposed in terms of analysing roots causes of the current crisis : this one and the one done  here : David Rosenberg on Austerity.

Two visions of the world. Take your pick !

Mine is 100% behind this guy's analysis, need I add for those who are not versant to Zh postings over the past year.

And, what he says about EMT Joan Robinson said back in the 1950-60s! 

Tue, 06/12/2012 - 09:00 | 2517493 AnAnonymous
AnAnonymous's picture

Interesting how? Classical US citizen business.

US citizens do not inform, they do not spread facts. They pander to an audience in order to cash on in.

That is why they are so enamoured with controversy.

Taking a look at the common panel of pundits hosted on a US citizen talk show:

the host plus generally four pundits:

to each question, the pundits will take the statistical distribution of an audience.

1- Yes, absolutely for
2- Yes, but...
3- No, but...
4- No, absolutely against

The host playing the person with no formalized opinion, maybe yes, maybe yes but, maybe no but, maybe no.

This is the statistical distribution of opinions in a US citizen audience.

US citizens do not inform. They pander to an audience.

By taking this route, they are sure that no matter who the viewer is, the viewer's opinion will be represented, giving the viewer the impression that she is part of the gang, that she is included.

US citizen business. Nothing interesting in it.

Tue, 06/12/2012 - 09:12 | 2517539 Chump
Chump's picture

You certainly find it interesting, seeing as you spend your days talking gibberish about it.

Tue, 06/12/2012 - 09:49 | 2517693 AnAnonymous
AnAnonymous's picture

I thought I was paid to smear US citizenism?

New song?

Tue, 06/12/2012 - 10:00 | 2517722 Chump
Chump's picture

Smear?  You have to be coherent to have such a concrete goal.  You are most certainly paid for what you do though.  What unpaid Chinese folks have the technical and economic ability to spend their days writing steam of consciousness nonsense on sites like Zerohedge?

Tue, 06/12/2012 - 10:03 | 2517733 AnAnonymous
AnAnonymous's picture

So I am paid to write on US citizenism. How funny indeed.

Tue, 06/12/2012 - 10:06 | 2517750 AnAnonymous
AnAnonymous's picture

You have to be coherent to have such a concrete goal.


What do US citizens know about coherence?

Lets give it a try: US citizens declare that freedom is an unalienable right to human beings and keep human beings as slaves.

How coherent is that?

Does it smear US citizenism or not?

Let see what US citizens have to tell about coherence.

Tue, 06/12/2012 - 10:09 | 2517762 AnAnonymous
AnAnonymous's picture

Now for the present days example.

A US citizen claims that a person is paid to report on US citizenism.

Later, the same person sets as a compulsory point that reporting about US citizenism has to be interesting for that person, since it is performed.

How coherent is that?

Tue, 06/12/2012 - 10:19 | 2517805 Chump
Chump's picture

Your comment?  Not coherent at all.  Stop using unnecessary qualifiers until you have a better grasp of the language.

Oh shit, you're probably getting paid per response or something, too, and I'm just helping.  No more.

Tue, 06/12/2012 - 10:15 | 2517788 Chump
Chump's picture

Well, slavery is part the US's past, that's for sure.  Notice the key word being "past."  This is ignoring various debates over whether or not income and property taxes constitute slavery in the same sense.  I'd rather spare you (and myself) the metaphysical and semantic discussion.

I'm wondering, though, how you manage to ignore the plank in your own (government's) eye?  If slavery is such a concern for you, do you not have plenty of social causes to pursue right in your own backyard?  Surely your government wouldn't shoot you or imprison you for criticizing its policies.

Tue, 06/12/2012 - 09:08 | 2517526 Chump
Chump's picture

Nothing wrong with opposing viewpoints.  That's what makes this ZH and not ShitNBC.

Tue, 06/12/2012 - 09:27 | 2517610 falak pema
falak pema's picture


Tue, 06/12/2012 - 09:33 | 2517632 Chump
Chump's picture

Oh stop, you.

Tue, 06/12/2012 - 10:00 | 2517719 AnAnonymous
AnAnonymous's picture

US citizens pander to all audiences possible. That is why they like controversy.

Any one going the way of this US citizen will be given a seat and considering the ratings results will be made permanent or ousted.

Tue, 06/12/2012 - 10:03 | 2517727 Chump
Chump's picture copied and pasted that first part!  I'm tellin'!

Tue, 06/12/2012 - 05:35 | 2517219 ebworthen
ebworthen's picture


Remaining "retail" investors are either locked into equities via pension plans or defined 401K plans; everyone else has LEFT THE BUILDING.

The rest are robot whales and two-bit gamblers.

Fuck Wall Street and the diseased hounds of Hell they rode in on.

Tue, 06/12/2012 - 06:44 | 2517244 pcrs
pcrs's picture

Any theory that starts with politicians are gullible or politicians are stupid, is wrong. They have your ass for breakfast. They take most of your income and confiscate your productive life and there is nothing you can do about it. They are NOT stupid or gullible.

They might appear that way, but their stumbling into power is just a masquerade of a wolve in sheep skin to approach the target without being noticed.

They are evil, they use coercion and force to take your life. Don't run to them for safety. Governments killed 200 million people world wide the past 100 years. They are funded by theft and preserved by force. Blood is their currency.

Tue, 06/12/2012 - 06:49 | 2517246 TWSceptic
TWSceptic's picture

"Allow debt forgiveness for the 99% and institute austerity for the 1%—they can afford it."


What bullshit this is. This guy is a hardcore liberal, socialist or communist. The 1% can't possibly solve the problems we're in, also this guy clearly doesn't understand what austerity means. Forgive debt for the 99%? LOL. Is this a joke?


Surprised this garbage is posted here.

Tue, 06/12/2012 - 11:12 | 2518032 Demologos
Demologos's picture

You are right that the 1% can't pay for it all now.  The pyramid of debt has gotten so big that it is crushing 100% of us.  Even the 1% is being crushed.  They just can cushion the pain better than the rest.  But eventually, they will be as flattened as the rest of us.  The debt is unpayable.  The only way out is to wipe it clean and start over with a system that generates real wealth, i.e. better standards of living for all through the rapid introduction of new technologies created through the fostering of scientific progress.

Tue, 06/12/2012 - 07:55 | 2517334 neversink
neversink's picture

On yur solutions:

1. Reenact the Glass-Steagall Act. I agree. How many politicians say the biggest mistake was revoking the Glass-Stagall Act?? All of them. How many politicians have offered legislation to reenact the G-S Act???? Not one!!!!!! What does this tell you?

4. On allowing debt forgivenes for the 99%. The government should have paid off everyone's mortgage -right or wrong - in the first place, rather than bailing out the banks. If everyone's mortgage had been paid off, then the banks would have gotten their money back from the loans, toxic assets would have gone away, people would have had money to spend, and there would have been no QE or twist!!!!! But No, the people of this country are not too big to fail.... only the banks and AIG. 

Tue, 06/12/2012 - 10:03 | 2517731 Demologos
Demologos's picture

Not true!  HR 1489 gained four co-sponsors in the past week.  It is bipartisan.  The reason more have not jumped in is that they are more afraid of what their bankster/wall street bosses will do to them than they are of the pitchfork and rope brigade.  I'm afraid they will wait until the pitchfork and rope bridgade is coming down the street to do the right thing.

Tue, 06/12/2012 - 08:34 | 2517421 Winston Smith 2009
Winston Smith 2009's picture

The following is an essential part of any REAL reform.  Stop the UNSECURED lending of money backed by nothing.  It is nothing other than outright counterfeiting and its negative effects are huge:


A one-sentence Bill that, were it to become law, would instantly end "too big to fail" and yet let you grow as large as you'd like - provided you are gambling with your own money and not the sovereign credit of The United States.

Tue, 06/12/2012 - 08:51 | 2517472 AnAnonymous
AnAnonymous's picture

this hoary old EMT economic dogma, used by duplicitous bankers and hedge fund managers to con US politicians and 99% of Americans.


No. Nobody is conning nobody.

First point: US citizens who happens to be bankers. Because US citizens are duplicitous due to their eternal nature.

Therefore a US citizen who is a banker is de facto duplicitous.

Second point: US citizens know that their US citizen economics is just propaganda and fantasy. But they also know that as for so many processes, there are good sides and wrong sides.

US citizens are not saps to their own lies. They know they are lies and they also know that they benefit greatly from lying.

US citizen economics.

Tue, 06/12/2012 - 08:53 | 2517474 mikesswimn
mikesswimn's picture

Mr. Prentis,

Let me start by saying that I generally agree that EMH leaves something to be desired.  That being said, upon reading your research that you linked in the article, I see some glaring issues with your approach.  What appears to be problematic is that your approach allows your model to work in a vacuum.  You didn't actually act, or utilize these rules over the period defined in your paper.  Do you really believe that if you were making abnormal returns using this model that others wouldn't copy your approach, thus muting your results?  If these other actors were utilizing your model, do you truly think that you could so easily flush out relative maxima and minima?  Additionally, it's not exactly the most complex of models ever developed, do you have any evidence that you're the first one to think of it?  Have you ever put it into practice?  To review, here are my two main complaints about your research and claims:

1) If you actually invested the $225 over the period, and utilized your trading rules, the effect your portfolio and your actions would have on the market and it's participants is non-trivial, and thus, your future returns are inherently flawed.

2) The model's construction suffers from severe "look ahead" bias.  You offer no theoretical backing for your selection of 355, 353, and 5 degrees for equations (3), (4), and (8) respectively.  These appear to be reverse engineered to allow your model to work, and given my earlier note, it appears unlikely that these would hold if you were actively participating in the market over the period in your paper.

If you consider these two issues, I see no reason to assume that you've empirically disproven weak form EMH.

Tue, 06/12/2012 - 10:21 | 2517815 Eric L. Prentis
Eric L. Prentis's picture

I explain where those supporting the EMT go wrong in the data and methodology they use. I follow all the EMT theorists’ rules for testing the EMT. Based on that, the EMT is dead wrong, period!


In financial economics, we cannot do controlled experiments in a laboratory, like those in the physical sciences. Consequently, do not criticize our social science research methods—we have inherent limitations.

Tue, 06/12/2012 - 11:39 | 2518170 mikesswimn
mikesswimn's picture

Mr. Prentis,

Don't misunderstand me.  I'm not coming out in favor of the EMH constructs set forth by Fama and Samuelson, and I don't disagree that it's misguided at best.  There is a plethora of research done, of appropriate rigor, that casts dark shadows of doubt upon the EMH.  Also, I am not criticizing the research methods of social scientists, and I recognize the limitations that their respective fields face in constructing experiments.  What I am criticizing is your methodology in particular, which appears to be poorly considered and whose conclusion does not represent what can be reasonably called a refutation of the weak form EMH.  Whether a controlled experiment is possible or not doesn't change the fact that the construction of your model was built using known values of future events, arbitrary values without justification, and ignored non-trivial market action effects.  Additionally, merely following Fama and Samuelson's rules for testing EMH does not necessarily mean that their rules are appropriate or adequate for the task you have chosen to undertake.

If you were interested in correcting these problems, less arbitrary model rules would be a good start.  For instance, if you had your model sell/buy at exactly when f'(L9)=0, rather than build out rules dealing with specific tangent lines.  This would help overcome my issues with the obvious and troubling "look ahead" bias found in your research.  That is, unless you have good reason to select the given slope lines for your model, then I would interested to see how and why they were constructed. 

Beyond that, a perfectly reasonable way to test your model is to take $5,000 and open an account to see if your model actually produces abnormal returns.  Then, you'd have pretty hard evidence and a pretty nice return on your investment.  That sounds like a win-win situation to me.

Tue, 06/12/2012 - 09:01 | 2517506 Umh
Umh's picture

A theory is a hypothesis with consensus backing. This may have nothing to do with it's validity. Calling it EMT instead of EMH is just building a taller strawman to knock down.

Tue, 06/12/2012 - 09:14 | 2517546 neversink
neversink's picture

Anorther solution...

6. Banks should not be allowd to margin. Let them risk what they have, not imaginary money up to 100 times what they have. 

Every bank is still margined to the teeth. Obviously the world banks have margined everyone's money and is gambling with it. How can we not fail with such a Ponzi-Madoff scheme in place???

Tue, 06/12/2012 - 10:01 | 2517725 AnAnonymous
AnAnonymous's picture

A solution to what?

It is not because you are getting less and less a share of the loot that US citizen economics do not work.

If it aint broken, do not fix it.

US citizen economics work, wealth is extracted and concentrated.

Tue, 06/12/2012 - 09:25 | 2517603 mjk0259
mjk0259's picture

Making stock price models that beat the market retroactively is easy. If this one beat it going forward, why would he tell anyone instead of using it to make profits.

Tue, 06/12/2012 - 10:34 | 2517859 Eric L. Prentis
Eric L. Prentis's picture

An out-of-sample study supports my conclusion. Please see my published journal research— here and here.


As to your second point, please see my answer to Infiniti.

Do NOT follow this link or you will be banned from the site!