Saturday, January 5, 2008

Ivory Tower Theories

While earning my degree, one of my finance professors required the class to read Burton Malkiel's "A Random Walk Down Wall Street." Malkiel's book preaches Efficient Market Hypothesis (EMH), which has become dogma for many in the financial world. For a time, I became a believer in EMH.

Efficient Market Hypothesis (EMH)

  • The stock market is a perfectly competitive market
  • All information is known
  • Prices reflect all information
  • The only way to beat the market is luck
  • Luck will run out quickly
A few years later, as I began to make investment decisions, my research revealed some notable exceptions that didn't line up with Malkiel's EMH theories. For example, how do you explain Peter Lynch and Warren Buffett? What secret code had they cracked to beat EMH?

I later came across the "January Effect" and the "Persistence of Performance" mutual fund study (Sheldon Jacobs) which further motivated me to look beyond EMH for some explanations.

“What could be more advantageous in an intellectual contest — whether it be chess, bridge, or stock selection — than to have opponents who have been taught that thinking is a waste of energy?” -Warren Buffett

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