Markets are Efficient if and Only if P = NP
papers.ssrn.com
papers.ssrn.com
How long would it take you to gain enough capital to start moving prices? If you have a systematic edge on all trades...
In any event, I didn't find OP interesting the first time and I don't know. Most people aren't using OP's extremely strong definition of efficient market, but merely saying that humans and current algorithms cannot over long periods extract money; it's a statement about the market vs other actors, not markets versus omniscient gods.
He proves that, but it doesn't seem that surprising to me.
I'm not saying I agree with this, I'm just saying that that's what you're taught in school. If there were a way to prove this indisputably incorrect then it would probably be an interesting result.
Markets are provably not 'instantly' efficient because arbitrage exists. Arbitrage is simply not possible in an efficient market, because it's an exploit of inefficiency.
However, exploitation of abitrage (and of knowledge generally) is what makes markets largely efficient.
Because the market is a hideously complex system that only produces its information as an evolved, emergent system, then it is likely that its output is not precise but only extremely close to optimal.
I'd submit that worldviews based on 1-dimensional criteria like "market!" or "hayek!" fall pretty far short of the mark. Although I can see the attraction. It's nice to simplify things to a level where a human being can actually have the answers with a high degree of confidence.
Both the tea-party-hayekians and the linked paper fall into this trap.. what about information asymmetry? What about borked incentives? What about just plain stupid? "I played golf with the guy so I'll buy it"? "I know these instruments are crap but I'll sell them to my clients to get them off my balance sheet"?
A friend was telling me at his old job, they actually worked in season tickets to a luxury booth at Yankee stadium into a very significant tech purchase. Is that market efficiency?
The fall of 2008 wasn't a free market. In particular, the government was forcing lenders to accept more risk (viz sub-prime borrowers) than they would otherwise have done. Also, the lenders themselves incorrectly modeled their risk exposures.
None of your objections:
what about information asymmetry? What about borked incentives? What about just plain stupid? "I played golf with the guy so I'll buy it"? "I know these instruments are crap but I'll sell them to my clients to get them off my balance sheet"?
hold any water:
Information asymmetry (also, incorrect information as with lenders in '08): This has nothing to do with the efficiency of markets. The efficient market hypothesis depends on actors behaving rationally to achieve their goals. That does not mean that those actors will always be correct. For example, in The Myth of the Rational Voter[1], Caplan describes how it's actually rational behavior for voters to vote irrationally: the benefit of the degree they can sway the election is far smaller than the cost of acquiring sufficient knowledge to determine what candidate would most benefit them.
Bad incentives: it's the incentives (see "Invisible Hand") that make things work properly! To the extent that the incentives are wrong, these are the regulations, the aberrations that make things deviate from the free market. In your '08 complaint, that was the Congress forcing lenders to take on borrowers that would not normally have qualified. It also comes from externalities, places where our laws prevent the free market from completely accounting for the costs of an action. For example, because air and waterways are held in common by the government, without a real owner, there is nothing capturing the cost of pollution. Thus, incomplete property rights leads to market failures. If the government got out of the way, the market could resolve it (see "Coase Theorem")
Stupidity: as separate from your other points, well, there's no such thing -- at least not that we can perceive. Mises shows that (a) each person acts to maximize his own utility, and (b) it's impossible for outside observers (and frequently even the individual himself) to know what ends he is attempting to achieve. Thus, if your hypothetical golfer places some personal value on the relationship with his golf buddy, it may be perfectly rational for him to spend extra few bucks buying from the guy. And you and I certainly aren't privy to enough information to decide that it's not so.
Fraud: your Yankees example seems to be an example of fraud, and thus can't be considered a free market transaction. Fooling someone into a transaction is no different from forcing them into a transaction.
That said, research in psychology and econometrics has shown that people do systematically misconstrue very large or very small values, leading us to sometimes choose differently from what we really intend. The only solution to this, of course, is to formally model the problem to enable us to act rationally. In this day and age, such models are de rigeur, but -- as I note above -- the investment in the models itself has some risk: we're balancing correctness against cost to develop and feed the model. As with the rational voter, this can lead us to "rationally irrational" behavior, but this is just a meta-behavior of the free market, not an indictment of it.
Moreover, there is no way around any of the issues that you cite. All of these things can be applied equally -- if not more -- to government regulators (see "public choice economics", "regulatory capture", etc.). Why would you want to give power to entities who won't be able to use it any more wisely than the people themselves?
[1] http://en.wikipedia.org/wiki/The_Myth_of_the_Rational_Voter
We're in the real world here. If the real world held up to a given person's theory, communism would've worked. You just have a different theory.
I'm not claiming markets are terrible, they're usually the best way to do things. But when you pigeonhole yourself into an absolutist position, you've guaranteed that you're going to be flagrantly wrong sometimes.
That's a fair criticism of my reply. My initial statement almost had a flavor of "free markets are perfect", whereas what I really believe is that "free markets are the best system possible".
So, no true scotsman?
But I don't think that's a fair criticism. There is a clear, well-defined concept of "free market"; it's not like I keep backing off my statement every time someone scores a hit on my argument. If the theory can explain exactly why the various regulations on the market have the observed result -- that is, if it has scientific predictive value as opposed to an irrational belief system -- then I don't think I'm susceptible to this criticism.
In high school physics we did Newtonian mechanics assuming a frictionless surface, etc. It turns out that our experimental results didn't match up with what really happened, because we had friction and other factors. But we learned more physics, so even though we didn't have access to that frictionless surface, we could explain why the results differed, and predict just how those differences would appear (friction is proportional to downward force, etc.).
You're criticizing the market theory because the observed results have those "frictional" differences, even though we can tell you what is causing the friction, and predict (albeit to a limited degree at this point) what the future effects of proposed "friction" (i.e., regulation) would be.
The crash of 2008 was preceded by 20 years of deregulation. And the explanation? Too much regulation! A billion dollars in loans to minorities must explain the 2 trillion dollar problem!
There's nothing wrong with thinking a free market's the way to go for a given problem, provided you got there by engaging your brain rather than taking it on faith. Once you do that, you might find yourself thinking things like "Hm, maybe capital gains should be taxed as ordinary income", or "Hey, turns out it's mathematically impossible to balance the budget by cutting domestic discretionary spending".
The mother of all financial regulatory machinery, the central bank, is considered to be the primary cause of the crash by many. I find the argument reasonable. Correct or not is another story, but how can you dismiss the statement wholesale?
I don't want to be nitpicky here, but this is a conversation about not turning your brain off. Are you referring to the federal reserve? They don't regulate anything. The SEC? They're in no way similar to a central bank and have been regulating progressively less over the last 70 years. What changed in 2008 that made their regulation more burdensome?
If you're making a statement, it's on you to back it up. Shouting "regulation!" with no insight behind it might work in your social circle but in mine, it's turning your brain off.
Again. This subthread is not about turning your brain off.
The fed changing interest rates is not regulation. It's not writing laws, it's not forcing anyone to do anything.
I'd appreciate it if you quieted your condescension. For someone who didn't even know that the United States had a central bank, you are extremely vocal about the topic of finance. We're all here to learn and exchange.
Even if actions of The Fed are not necessarily regulations themselves, the fact that The Fed exists at all and is able to exert influence is certainly the result of law. Understanding this, I don't have a problem with conflating the actions of The Fed and the regulation that enables The Fed-- "regulation".
There is healthy debate regarding the cause of the 2008 crash. Economics is not a science proper, and the data is noisy. You cannot simply write-off the argument wholesale by latching on to the debatable causal link between "de-regulation" and the crash. Unless, of course, you turn off your brain.
Thanks for the counter-condescension.
To the original point, they don't write regulation and it's hard to call a fixture of the last 80 years "regulation responsible for a recent incident", due to the fact that at some point there was a law.
"reg·u·la·tion [reg-yuh-ley-shuhn] noun 1. a law, rule, or other order prescribed by authority, especially to regulate conduct. ..."
http://dictionary.reference.com/browse/regulation
"The Federal Reserve System (also known as the Federal Reserve, and informally as the Fed) is the central banking system of the United States.
Its duties today, according to official Federal Reserve documentation, are to conduct the nation's monetary policy, supervise and regulate banking institutions, maintain the stability of the financial system and provide financial services to depository institutions, the U.S. government, and foreign official institutions."
http://en.wikipedia.org/wiki/Federal_Reserve_System
"Mission... supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers..."
http://www.federalreserve.gov/aboutthefed/mission.htm
(Emphases mine)
The federal reserve manages the cash rate. The don't directly specify the risk premium spread associated with risky loans.
If someone offers a no-recourse billion dollar loan with no obligation for collateral, the rational financial decision is to take the loan, and invest the money. If the investment appreciates pocket the money. If it goes south return the investment and say "your problem" to the lender.
The federal reserve said they thought self interest would ensure the banks would not invest stupidly.
I don't see how this argument changes if overnight rate is 10% or 1%.
Care to share a reference that backs up that argument? I'm not doubting that there may be an argument, just interested to read that point of view.
If you're willing to generalize the comment to say that the crisis was primarily due to the heavy hand of the federal government, then I offer these two links. They're both op-ed pieces, so shouldn't be considered definitive research, but they're pretty solid evidence that some serious people do blame the government's regulation (as opposed to de-regulation).
1. A Government-Mandated Housing Bubble http://www.forbes.com/2009/02/13/housing-bubble-subprime-opi...
2. How Government Stoked the Mania http://online.wsj.com/article/SB122298982558700341.html
To the extent that government regulations are less strong than physical laws, isn't the market still free? For instance, methamphetamines are illegal, but they're still produced, distributed, and retailed; just with a higher cost for all involved than if they didn't have to take precautions against, and accept the probability of, detection and punishment. Given the incentives in place, the supply and demand curves for methamphetamines still meet, and the market clears.
I've always found the belief that markets can withstand any form of interference except government regulation fairly bemusing.
One side-effect that falls out of this more cosmopolitan view of free markets is that the fall of 2008 was the efficient outcome. If market participants had information about what would happen strong enough that they were willing to bet on it in 2005-2007, the catastrophic drop in 2008 would not have happened as it did.
Sure it does. But the individual actions that occur in so doing are different than they would otherwise be. So you've got hordes of young black men (yes, stereotyping, but to make a point) killing themselves supplying drugs. This wouldn't be happening in the free market; you'd be buying it legally from your pharmacist, or even the local convenience store. Those young men would still be alive.
the fall of 2008 was the efficient outcome.
I've no doubt that this is true. Unfortunately, even in that, the perversions of the market have not been allowed to resolve themselves. We've got the "too-big-to-fail" thing that is continuing to incent risky behavior, and we've got the government shoring up housing prices, preventing that bubble from deflating.
It's fairly common for traders managing (or depending how you look at it, gambling) other people's money to be paid a percentage of the total money under management (for the sake of argument, let's say 0.5%) plus a much larger percentage (10%) of the upside.
That this leads to perverse incentives is, I hope, obvious to everyone here - I've literally sat down with traders and run best guess numbers incorporating the risk of getting fired (or losing investors, shutting down the fund, etc.), difficulty finding another gig doing the same thing vs. the potential gains, and the mathematical conclusion is almost always the same: go all-in, take on as much risk as you can possibly manage, and you'll do better personally than if you invested safely. The only real question is a moral one, i.e. do you care enough about doing what's right to actually try to preserve your client's money rather than gamble it away for a shot at a bigger prize? [Interestingly enough, I've found that most do, the problem is that there's a small subset that don't give a shit, and their abuses taint the entire field]
This type of risk-seeking unquestionably played a role in the recent collapse, I don't really see how that can be denied - sure, government incentives triggered the initial housing market buildup and drop, but IIRC that was initially only a 4% correction, it was only because of how massively leveraged the financial sector had become w.r.t. credit that such a drop had any impact on anything at all.
Do you really think the payment incentives in the financial sector are helping the market work properly? Or do you think that those payment schemes (a nibble of the principal and a chomp of the upside) are somehow caused by government meddling?
IMO, the problem is that it's a mistake to assume that the negative effects of "government meddling" end with official government. Any time you put a group of people together and have them agree on rules and regulations, especially ones about how to distribute money amongst themselves, you run the risk of creating incentives where individually self-interested actions actually work against the group. This applies to corporations, clubs, families, teams, etc., just as much as it does to governments.
This is a minor detail, given that that was just an example you were giving; but in case it piqued anyone's interest, I'll correct it. That's not actually the explanation Caplan gives for voters acting irrationally (indeed, there's nothing that even appears irrational about that; that's obviously rational behavior). What Caplan argues is that voters rationally vote irrationally because they have preferences over beliefs, giving voting in accordance with false but preferred beliefs psychological benefits, and that if these psychological benefits outweigh the negative effects of the irrational voting, discounted by the low probability of deciding the election, it is rational to vote irrationally.
As I pointed out above, the number of loans made because the government said-so is not enough to account for the problems they encountered. Because of the mortgage-backed securities industry, there was incentive for banks to make sub-prime loans and offload the loans (and the risk) elsewhere. In other words, the government's requirements did not lead to the glut of sub-prime loans.
I also find your comment about lenders incorrectly modeling risk strange - it's a true statement, but I don't see how that means the market wasn't "free."
Home prices crashed and then more or less stabilized. So yeah, I'd say the crash was close to an optimal price correction.
http://research.stlouisfed.org/fred2/series/SPCS20RSA?rid=19...
I'm a little confused how why you would believe people who follow Hayek are unfamiliar with questions of information asymmetry and borked incentives. After all, don't they form the basis of "The Road to Serfdom"?
I've never heard a self-proclaimed Hayek follower (note that word, follower not thinker) say "I'm worried that the private sector doesn't arrive at the correct incentives in this case" about anything, ever. That's why I'm confused.
If you want to see Hayek followers concerned about such issues, go read the blogs of assorted gmu economists (Tyler Cowen, Robin Hanson, Bryan Caplan, etc).
http://www.overcomingbias.com/2009/11/require-baby-paternity...
Or see anyone who pushes the signalling model of education.
That's an understatement. It was a significant theme throughout his work.
The free market is more force of nature than construct of man, like gravity or a huge river. It can be harnessed, but it will efficiently crush you if you get in its way. It is also like the forces of nature in that it is extremely difficult to successfully harness it when one willfully chooses to not understand it because one does not "like" it, which is why the track record of social systems that start out with "Let's pretend the market isn't a force of nature but that we can will it into compliance with our ideology" tend to fare so poorly in practice; it's hardly any different than assuming gravity won't actually hurt you if you just love hard enough, then trying to get into rocket design. (The problem isn't that you won't get a rocket off the ground with such a plan, the problem is that you will....)
This concept that in 2008 the market was responding to incentive misalignments created by government regulation.. what regulation? All we did was deregulate from 92 onwards. Are you gonna claim that a billion in fannie/freddie loans to minorities caused the problem? What about the overleveraging, the AAA credit ratings? Those were government problems?
It seems like a whole bunch of individuals played the "greater fool" theory as long as they could, and what we wound up with was the opposite of efficient, by your definition. I'm not necessarily saying more regulation would've prevented that, aside from generally being a brake on everything, but it's a hell of a bad case for the wisdom of markets.
Where was the enormous arbitrage opportunity left behind, and why didn't you (or anybody else) exploit it?
Maybe you can answer that, but if you can't, you're not arguing for "inefficiency", you're still arguing "not good".
You also appear to be conceiving of regulations as something you simply have "more" or "less" of, which is not a useful mental model. What matters about regulations is their content, not their quantity. And what the content of our regulations created was A: mandating that banks make loans they would not have made without them and B: an implicit government backing for those bad loans.
Have you looked at the balance sheets for Fannie & Freddie lately? They're not bleeding a billion here or there.
Also, yes, the credit rating agencies are government creations as well. There are regulations (ahem) that require certain entities to take certain actions based on the word of the rating agencies, causing them to no longer just be groups of people stating their opinion, skewing their own incentives and raising the incentives others have to game them.
Anyways, 10 years is pretty darn not good in my opinion. I'd call it inefficient, as far as pricing is concerned.
Agree on "more or less" regulations being a not-useful mental model. It seems to follow from that contention that "regulations!" isn't a one-word answer to any question of who to blame for anything, or how to solve anything.
RE: Fannie and Freddie I have not looked at their balance sheets. I'm under the impression that whatever the problem is with them, it's dwarfed by the size of the financial crisis, ergo they're not primarily at fault for the crisis. Moreover, the program to lend to minorities had been in place for decades. Seems hard to blame it for the 2008 meltdown, why not sooner?
It does seem that any regulations putting institutional faith in the ratings agencies are wrong-headed.
Housing subsidies directed at minorities were increased over time in the Clinton and Bush administrations, but weren't large compared to the massive overall portfolio.
This is false. The Community Reinvestment Act, passed in '92 and periodically ratcheted upwards thereafter, forced banks to increase loans to minority groups. It issued guidelines on how lenders should evaluate borrowers for these purposes:
Affirmative-action policies trumped sound business practices. A manual issued by the Federal Reserve Bank of Boston advised mortgage lenders to disregard financial common sense. "Lack of credit history should not be seen as a negative factor," the Fed's guidelines instructed. Lenders were directed to accept welfare payments and unemployment benefits as "valid income sources" to qualify for a mortgage. [1]
While not a regulation issue as such, it's also true that attempts to rein in Freddie Mac and Sallie Mae (semi-governmental entities both) were rebuffed by Congress; even when we knew there was potential trouble, the regulators wouldn't allow market concerns to dictate to their beast.
[1] http://www.boston.com/bostonglobe/editorial_opinion/oped/art... (note this link took forever to come up in my browser)
If we accept that the free market can act in ways which are detrimental to the global objective function (without loss of generality, let's pick your favorite, e.g., "Everyone gets food", "Individuals have class mobility", "I can shoot and eat the homeless for sport" etc.), do we as a society have a moral obligation to adjust market behavior via regulation or incentives? How does one reconcile a desire for free markets with a desire to satisfy other human goals?
I think it's possible to regulate effectively, but the problem is that it requires an engineer's approach, not a government's approach. One must be able to adapt, admit one is wrong, and generally regulate at the incentives, instead of being required to stay politically viable and only then regulate, be politically unable to admit error (and via the mechanisms of politics, become insulated from the facts that would show error), and be continuously stuck in the regulation of the effects instead of the incentives that got us there. Oh, and as I alluded to previously, being regulated by people who won't even look at the mechanics of the market squarely because they think they're intrinsically evil because sometimes they make bad things happen (which they definitely do!) isn't a great start to engineering success.
Yes. The market can be evil by human standards, just as gravity feels pretty evil when you're in a crashing plane. But you gotta deal with what really exists, not what you wish existed, and when harnessed properly it's one of the bigger forces for good we've ever discovered.
There are plenty of real-world examples of this. In all cases, free trade will make all parties better off on the whole. However, the effect of doing so may be that individuals at the margin lose out, e.g., an unskilled factory worker may find that someone in China is doing what used to be his job. It's pretty well decided now (although not without any controversy) that, at the margin, minimum wage laws increase unemployment in the lowest-paid workers.
The fact that some deregulation may have (localized) negative consequences shouldn't automatically disqualify them: there are more choices than just "let the market run free" vs "continue the regulation". We can, for example, get the benefits of that free trade, and use a portion of the economic gains to finance job retraining programs.
However, I'd also like to point out an implicit assumption in your question that may be problematic. You refer to "the global objective function". Part of our difficulty is that there isn't such a global function that all can agree on. Indeed, it may be that some of our utility functions are mutually exclusive. Many people would say that we should optimize for full employment, but I personally think that's bunk: there are plenty of people who don't want to work, but do so because they need to buy food; they'd rather take care of the kids while the spouse works. The adoption of a single utility function to govern the country (something, it seems to me, that both Conservatives and Liberals would like to see) sells out American individualism, and the diverse lifestyles and values of our people.
I argue that the only function that a free market can optimize for is the market itself; all other consequences such as happiness, fulfillment, distribution of experiences etc., are side effects which arise from coupling the market to the world via the decisions of participants, regulations, etc. Only if you assume perfect coupling of the market to the global objective is the system morally optimal.
In all cases, free trade will make all parties better off on the whole
This, however, makes it sound like you are assuming perfect coupling in the absence of any regulation, or that your objective function is the execution of the free market itself, and not, say, the well-being of the individuals and societies participating in it. I must not understand you correctly.
If we can agree that capital is the means by which a person can achieve fulfillment (I don't just mean by "being rich", obviously. It may enable the person to donate to charity; or that person's labor, which which has a monetary value, may achieve some end; or to obtain medical care to cure an ailment; etc.), then I can see an answer.
In the free trade example, opening borders to trade expands the economies of both nations. That's pretty much the same as saying that more capital is available within both nations, which means that -- across the whole population -- people are better able to move up their utility function (i.e., achieve self-actualization). In other words, because money -- capital -- has the power to buy or enable other things, then our positions may be compatible.
Of course, some individuals may benefit more than others, and indeed, some may find themselves worse off. That's where some would claim that we as a society owe compensation to some, to pay for our own gains.
Looking back at what I just wrote, it seems the crux of the argument, then, is the degree to which you can believe that capital can provide the answer to whatever your objective function is.
I'm going to reject the example of a market in slavery. This is the very epitome of a non free market. The slaves themselves are being forced into the transaction, and since a free market, by definition, requires rational actors entering the transaction of their own free will (because they all expect to be better off in the end), it cannot be considered free.
The classic examples of market failure are "tragedy of the commons" problems due to externalized costs, and public goods that would suffer "free rider" problems, like national defense. The externalization problems are due to our legal framework for property rights; a system that fully allocates property rights (e.g., some person owns this river; some person owns the air) would fix this, as demonstrated by the Coase Theorem. The free rider problem is stickier. They do turn out to be much rarer than people believe (e.g., the classic example is the lighthouse, but historical research shows that in the past, these have been provided by markets), but they're not entirely fictional, and I don't have a good answer to the overall question at the moment.
That is not to say it was good for the population, but it was a reasonably efficient reaction to the information the market had about the state of affairs. Note that it didn't fully reflect the entire state of affairs because the market did not have sufficient information, and still doesn't. (I think if it did, the S&P 500 would be about half where it is now.)
The thing that makes me listen to people like Mises and Heyek is that other people who follow their teachings were telling me in 2001 that there would be a housing boom and bubble, and that it would crash eventually due to the inevitable excesses of a bubble. I researched this hypothesis and decided I agreed with it. This made it very easy for me to watch housing prices go up, profit from it, notice when things were ready to change, and then profit from the change.
I think the question of whether markets are efficient or not is one that is placed in a vacuum and thus meaninglesss. Is the market more efficient than government? Yes, always. (It is impossible for a central planner to have sufficient information to set prices correctly.)
Were there people who had the same information as I did, but lacked the economic perspective that I did and thus made bad investments? Yes there were. This is happening today, in fact. We have politicians saying a lot of economically silly things, and the market reacts to this "information".
The question of market efficiency ignores the issue of perspective. You can talk about information asymmetry, and people can debate the amount to which it exists, but I'm absolutely certain that there is perspective asymmetry. I'm going to make a killing in the markets simply because so many people's perspective of economics comes from people like Krugman.
Is that efficient? Maybe-- the markets reflect the perspective of most people, even though they are wrong. But I don't really care.
I'd love it if I couldn't profit from this perspective asymmetry... the benefits to society would far outweigh the profits I'd loose from not being able to bet on these sure things. But so long as people will continue to roll their eyes when an austrian is mentioned, I'll take my profits as a consolation prize.
But I'd challenge your claim that you can actually profit from the general economic ignorance. The reason I'm so skeptical is because the market is so good at working around inefficiencies that even when we think something's got to collapse, it finds a way to keep going. (if you'll excuse me for anthropomorphizing)
Buffett's approach is to invest based on the fundamentals, and then just wait for the timing to prove him right. And he can wait a long time.
I view all the people keeping the price down (or up) when the fundamentals say otherwise as contributing to market inefficiency. (to the extent that the market doesn't shoe the "perfect objective" price) I agree that the market may be very efficient at showing the balance of the demand from people who think the fundamentals are one way, vs, those who think the opposite. In fact, I think that's what makes for the "inefficiencies" I'm talking about.
EG: Many say gold is in a bubble, while others say gold is under priced. I would say the market is reasonably accurate at putting the gold price at the equilibrium of these two views, but that the fundamentals makes one of these views right and the other wrong.
Efficient market hypothesis does not predict that the market will have perfect information or perfect pricing, or that stock prices will go infinitely up. It predicts that over the long term the market provides reasonably accurate pricing.
When explaining to folks I often use the example that the 15 minute delayed stock price feed (aka 'ticker') is less valuable than the real time stock 'ticker'. This is intuitive for many folks but the OP's work shows the math behind that intuition.
Stock price feeds are generally used by algorithms to anticipate the market price of a commodity and act when there is a delta between that and reality. They 'manufacture' new information by taking that real time stock feed and identifying trends. Their market value then becomes a function of their ability to identify trends sooner and thus allow for capturing the most value between the current price and the correct price.
The classical model of efficient, free markets ignores computational complexity and time bounds, as the article notes. These were reasonable approximations for a hundred or even twenty years ago, but I can forsee environments in which these factors lead to significant asymmetry. I question whether humans can really compete successfully in this environment, and whether the process of doing so is really best for us.
[1] Cases in point: Amazon, insurance companies, grocery stores, every major retailer, Google, high-frequency trading firms, airline ticket sales.
I'll hazard a guess the computer scientists are right, but most financial academics will probably get by just fine if markets are approximately efficient - if prices can be estimated in probabilistic polynomial time.
My amateur understanding is that most academics get that it's a simplifying assumption, but that a lot of other people treat it as a guarantee. It's sort of like people who learn a little about evolution and then conclude that a) we are the most highly evolved organism on the planet, and b) we are therefore perfect.
I know little about evolution and assume that bacteria are the most evolved because they have a faster cycle of reproduction, and stronger selective pressure.
> My amateur understanding is that most academics get that it's a simplifying assumption, but that a lot of other people treat it as a guarantee.
Most practitioners do understand that it is a simplifying assumption, and then ignore that fact, just as most engineers ignore quantum and relativity effects when calculating the required size of beams. The difference between the better and the simpler models is big enough to cause problems in economics.
That you know what selective pressure means probably puts you in the top couple of percentiles for evolution knowledge. The whole world is emphatically not like Hacker News.
E.g., it's not the least bit clear that finance needs to attack the worst case problems. Even if so, finance, anywhere close to reality, doesn't need to get solutions that save all of the last tiny fraction of a penny.
If relax worst case problems and saving the last tiny fraction of a penny, then the situation is MUCH different. E.g., once I got a feasible solution to an ILP with 40,000 constraints and 600,000 variables within 0.025% of optimality on a 90 MHz Intel processor in 905 seconds. More generally, here's an easy approach to the ILP problems: Just drop the integer constraints, solve with LP, and then round to integer values. For the LP solution, if insist, then use a polynomial LP solver. Crude? Sometimes. Always crude? No.
He's making a common mistake: He's assuming that because in general ILP is in NP-complete that good work on all practical ILP problems has to be too challenging, and that's nonsense.