A better way to teach EMH?

A better way to teach EMH?

While watching football this morning, I also kept an eye on the betting odds. As soon one team scored, the odds changed.

Instead of introducing the efficient market hypothesis to students as a theory about stocks and bonds, we should perhaps start by drawing parallels to sports-betting. It is hard to consistently make money betting on Premier League results. It’s not impossible, but it takes a lot of skill and/or luck to pull it off.

The same logic applies to beating the general rate of return in a market. Financial markets tend to adjust prices so that there are no obvious bargains. This is not a claim that sporting events never throw up shock victories, nor does it imply that markets never crash. If anything, it suggests that predicting a stock market crash is about as difficult as predicting a shock sporting victory.

Like comparative advantage, it’s hard for undergrads to grasp this idea. I have found that the sporting analogy works well as a stepping stone.

(While on the topic of the EMH: there’s a fun contrast between the predicament of Cassandra, who could perfectly predict the future but nobody would believe her, and the EMH. The more people believe in EMH, the less likely they are to actively search for arbitrage opportunities. This will tend to leave market-beating returns uncollected, nullifying the EMH. The converse also holds. In this respect, EMH is a self-defeating prophecy.)

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