Friday, September 04, 2015

Mood swings

Referring the recent stock market volatility, the New Yorker's James Surowiecki writes that, "The stock market is not the economy ..." but that "doesn't mean that stock-market crises can't become contagious ..."

There are, of course, many moving parts. These include the expectations of large numbers of investors (in stock markets and beyond in the "real" economy); expectations can turn on a dime and we have no models that helps us with this.

Market data come at us all the time from many sources. We can all observe pretty much the same things but processing and interpretations are all over the place and personal.

When the Great Recession hit it was fashionable to scoff at the idea that markets get prices right. But that's a straw man. The efficient markets idea is actually that prices are always wrong but are always being corrected; they simply reflect the latest available information -- but "latest" changes by the nanosecond. Look at asset price fluctuations. Latest information includes the latest investor mood swings. The notion of mood swings tells us much more than "animal spirits". 

It is not ironic to say that the efficient markets theory has passed the market test; consider the popularity of index funds.