Thursday, January 14, 2010

An old confusion

The Efficient Markets Hypothesis (EMH) is a pretty good conversation starter. Equilibrium requires that we somehow get to equilibrium. No $20 bills laying around sidewalks means that some are (have been) busy snatching them up.

So it is with the risk-return trade-off. It describes an equilibrium across financial markets. But very interesting things transpire as we move towards the equilibrium. So moving along the trade-off curve is one thing, but moving towards it is quite another.

Writing in the Jan 18 New Yorker, Malcolm Gladwell ("The sure thing: How entrepreneurs really succeed" -- partly gated) chooses to describe entrepreneurs (including Ted Turner and Hank Paulson) who have made a (financial) killing as "predators". That may be an unfortunate choice of words in these times. Many in politics and involved in popular discourse live in a zero-sum universe and associate wealth with theft. Do we call those who first see $20 bills laying around "predators"?

Gladwell's review is worth reading. If only we could live with two ideas at once: equilibrium is an interesting mental gadget, but it should not pull us away from the interesting discussions of how in the world we might ever get anywhere near it. In fact, the equilibrium idea and the story of the forces in play in diseqiulibrium cannot be separated.