Is the Stock Market Predictable?

Is the Stock Market Predictable

He asserted that “past, present and even discounted future events are reflected in market price.” “The market, or the aggregate of speculators, at a given instant can believe in neither a market rise nor a market fall,” he wrote, “since, for each quoted price, there are as many buyers as sellers.”

In these simple words and calculus is the earliest form of the efficient-market hypothesis (EMH). Unfortunately, Bachelier was so ahead of his time that “no one knew where to pigeonhole his findings,” as Benoit Mandelbrot put it. Although Bachelier boasted that his theory “resolved the majority of problems in the study of speculation,” his groundbreaking work barely landed him a professorship, and remained largely unnoticed – until Paul Samuelson.

But Samuelson differed from Bachelier in one important aspect. He believes that only excess return, or alpha, is unpredictable. This is because a stock price cannot fall below zero, although stocks are too competitive to be consistently outguessed. In short, Samuelson believed in the predictability of beta, but alpha is hard to come by.

In a letter to Robert Shiller, Samuelson further postulated that the market as a whole is macro-inefficient but is micro-efficient on the stock level. He wrote about “considerable macro inefficiency in long waves in the aggregate indexes of security prices below and above fundamental values”.

Shiller agrees from his vantage point as a behaviorist, as the human brain is simply not designed to know instantaneously and comprehend all information. On an aggregated level, the existence of trends suggests that market prices continuously adjust to new information. The evidence in his famous 2005 paper Samuelson’s Dictum and the Stock Market supports Samuelson’s hypothesis, and should answer the critiques about how this year’s Nobel seems to be shared by economists with contradicting views.

Read the whole article here.

About the Author

The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.

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