The strategy of momentum investing says simply to buy stocks that are rising in value and sell those that are falling. Abnormal returns should be crowded-out, but have somehow remained remarkably persistent. This column explains the role of periodic crashes – when momentum investing fails – using historical data from Victorian London and the CSRP-era US. Crashes happen just when momentum investing has been most successful, and fund managers are able to attract the most capital.
Benjamin Chabot, Eric Ghysels, Ravi Jagannathan, 30 January 2015
Roger Farmer, 22 January 2013
The efficient market hypothesis – in various forms – is at the heart of modern finance and macroeconomics. This column argues that market efficiency is extremely unlikely even without frictions or irrationality. Why? Because there are multiple equilibria, only one of which is Pareto efficient. For all other equilibria, the whims of market participants cause the welfare of the young to vary substantially in a way they would prefer to avoid, if given the choice. This invalidates the first welfare theorem and the idea of financial market efficiency. Central banks should thus dampen excessive market fluctuations.
Dimitri Vayanos, Paul Woolley, 18 January 2012
According to classical economics, there are no gains to be made in an efficient market. Yet markets are often far from efficient and the gains are often far from insignificant. So should investors follow the herd or rely on best guesses of fair value? This column argues that the optimal strategy depends on whether you are in for the short or long term.
Dimitri Vayanos, Paul Woolley, 05 October 2009
Have capital market booms and crashes discredited the efficient market hypothesis? This column says yes and suggests a new model that explains asset pricing in terms of a battle between fair value and momentum driven by principal-agent issues. Investment agents’ rational profit seeking gives rise to mispricing and volatility.