Investing - Theory, News & General • International (Non-US) versus US Equities (The "Arguments")

But the exchange shows why I find it absurd.
EMH means all information is captured including expected returns.
So either you use expected returns or you support EMH. You can't do both simultaneously.

EMH would hypothesize that people's opinions and ideas of future returns are incorporated into the price.

But it doesn't tell you what the return *is*.

And, in fact, it hypothesizes that different groups, using different (or even conflicting) models of expected future returns will trade according to their own ideas, beliefs, and models, and that the price is the aggregate of all their opinions, both bullish and bearish.

Simple example:

Jane's expected return model says Nvidia is going to underperform the market based on some fundamental analysis she does. So she sells it driving the price down.

But Mary's expected return model thinks fundamental analysis doesn't work for tech stocks and instead relies upon momentum, which she sees as currently on an upswing. So she buys the Nvidia shares that Jane just dumped on the market.

Thus the resulting price from Jane selling and Mary buying incorporates information from both Jane's fundamental analysis approach and Mary's momentum trading approach.

Despite the fact that both Jane and Mary are using completely different models about how to assess future expected returns.

I don't know what you are trying to say but to me this example just describing active traders. No can tell you what the return is to be.

Yes, active traders set the price.

And Susan who builds long term models will look at that price and say "I believe the price reflects the sum total of the opinions in the market, at present, using the present information, and ergo, the market is (reasonably) efficient."

But Susan is running a university endowment fund. So she has to make decisions about how much to allocate to stocks, bonds, alternative assets, private equity, etc.

So she will then use a model, perhaps one based upon PE ratios (which incorporates the price which she believes is efficient) to try to model future returns, so that she can decide how much the endowment should put into stocks vs bonds.

Susan thus is believing that the market pricing information is at least weakly efficient, but also using a propriety model to calculate future expected returns so she can decide how much to put into stocks vs bonds.

Statistics: Posted by SB1234 — Fri Apr 26, 2024 6:48 pm — Replies 5752 — Views 1238495