General Question

TheBot's avatar

Would the complete efficiency of financial markets be desirable?

Asked by TheBot (764 points ) March 22nd, 2010

Again market efficiency means the stock prices reflect ALL the information available. In other words, you cannot “beat the market”.

Assuming you could centralize all the information available and make the market automatically reflect it, it seems to me that the financial industry as we know it would for all intents and purposes disappear: no profit to be made because the market price is the perfect price = extreme reduction in the number of companies making a living out of their best guesses for stock evolution. So it would be a huge loss in GDP for any country to implement such measures.

But suppose someone did it anyways, you would have flawless stock prices, with companies that do well rewarded for it and vice versa. They would not be rewarded as much, mind you, as in a situation like the current one, where investment firms have trillions of dollars to invest in companies that do well.

What is your opinion on the subject? This topic may drift towards more philosophical questions, such as the idea of financial markets being purely psychological phenomena.

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30 Answers

dpworkin's avatar

Sure, so would frictionless surfaces and transmission lines with zero resistance.

jfos's avatar

I feel that this could only happen if there were:
– no competition
– no crime
– and unicorns.

jaytkay's avatar

People value different things, no matter how much information is available. Take a really simple example, say dinner forks.

We all know everything about forks. They have to fit your hand and your mouth. They have to pick up food. You get the same nutrition regardless of your choice of fork.

And yet, walk into a department store and you can choose among hundreds of different forks. Thousands if you shop online.

You don’t get entropy where people are involved.

bob_'s avatar

Efficient financial markets, free beer… yeah, that’d be great.

Just_Justine's avatar

There would be no money to be made if all stock markets were “efficient”.

TheBot's avatar

@jfos Lol I know that it’s pretty much unattainable, but just theoretically…

@jaytkay But what utility would someone find in owning a stock though? Emotional attachment to the company perhaps?

Just_Justine's avatar

@TheBot emotional attachment to what? a none moving entity that made no money?

jfos's avatar

@TheBot Perhaps people would still own stock, not to profit, but to have a stake in the corporation.

TheBot's avatar

@Just_Justine Companies would still exist. I meant it the way @jfos said it after your comment. A situation where you would own stake in a company just because you believe in the company.

Just_Justine's avatar

@TheBot what without profit? what a waste of time.

jaytkay's avatar

But what utility would someone find in owning a stock though? Emotional attachment to the company perhaps?

Speaking just for myself I would prefer:
* local companies over distant
* “green” companies over polluters
* Costco over Walmart (as stocks, not talking about shopping, though shopping, too)

TheBot's avatar

@Just_Justine Well investment companies would be pretty much dead, but other companies would still function through borrowing money from commercial banks and obviously selling their products and services, thus making a profit.

susanc's avatar

If a good, well-run company made good, useful products, it would make money, and its stockholders would make money.
Slow and steady.

Trading stock for the big haul is very different. Buying low and selling high has a lot to do with spin. Whether a company’s making anything good is almost beside the point in that game.
It’s about leverage, excitation, gambling fever.

jfos's avatar

@TheBot Dividends?

Just_Justine's avatar

@TheBot as soon as they made a profit, your efficient market idea would flop. You might be speaking of unlisted companies?

TheBot's avatar

@susanc I agree to some extent, but in the end in a situation of market efficiency, all financial statements of each traded company would be considered, thus integrating the company’s performance into the stock price. Mind you, valuation already represents a large part of stock expectations today.

josie's avatar

Information about companies that trade in the open market is already centralized and available. Companies file info with the SEC, plus companies like Value Line gather tons of information about companies and publish it for cheap. There is no lack of information about companies that trade on the market. The only other issue is how to value the stock. Since there is no such thing as intrinsic value, then different people will assign different value in a market place for different reasons, some of them subjective. For example, some people love Rolex watches and pay lots of money for them. I do not even wear a watch so I think Rolexes are not worth the money. In other words, there is no objective way to assign value. There is only the desire of the person who assigns value if and when they buy or trade. That is why IBM used to be the ultimate blue chipper, and now it is not. If that is what you mean by efficient, then there is no way it will happen. Before the fall of the USSR, the Communists used to joke that they would take over the world, except the Cayman Islands. When asked why, they would reply that it was the only way that they would know what anything is worth.

TheBot's avatar

@jfos Dividends are in a way rewards for owning stock. Suppose people do invest based on how well their values match those of various companies… would you still need to reward these investors when they already believe deeply in your company?

Just_Justine's avatar

@jfos dividends are profit and no a company only makes profit thus good returns for an investor based of performance, sentiment and current market trends. Not on an individuals value system. Although green and solar might be a bigger value enough to create a sentiment.

TheBot's avatar

@josie The information available today is past information, as well as publicly available information. But what about private information? If you were to integrate it in the system, then there would be complete efficiency.

Again I know efficiency is a form of utopia, but what if?

Just_Justine's avatar

@TheBot the last remark I made was for you thebot not @jfos long day loll.

Just_Justine's avatar

@TheBot you’d get no retirement funds for starters, no investors, ugh! I would be out of a job.

TheBot's avatar

@Just_Justine Oh ok. I’m sorry but I didn’t really understand what you said up there, could you rephrase it for me please?

Just_Justine's avatar

@TheBot which one I said a lot loll. I also keep referring to @jfos today no idea why never done that before. Poor guy.

TheBot's avatar

Lol just the ones with the dividends, and also the one with the retirement funds. ;-)

Just_Justine's avatar

@TheBot phew yeah that made it easier… spot on.

CyanoticWasp's avatar

It wouldn’t hurt, but even if everything was “known” to everyone, not everyone would be able to take advantage of the knowledge in the same way.

Consider a game of chess, or even checkers. The pieces don’t hide. There are no “chance” cards, dice or “luck of the draw”. Each player makes one move at a time, and the rules for and limitations on movement are exactly the same for both players, and (should be) known to both. But some players are consistently better than others, even so.

maudie's avatar

Perfect efficiency in markets is most likely impossible, unless we evolve to have some perfect empathic or telepathic abilities that allow us to be able to perfectly agree upon the value of every economic transaction that takes place in the market from the point of view of each actor in the market. Very very unlikely, but makes an interesting premise for a science-fiction novel.

If perfect efficiency were possible, I think it would still be undesirable, because inefficiencies are themselves problems that cause innovation to take place. If we reached a point where there was perfect efficiency in the markets, I think that would be tantamount to utopia, and in utopia all progress stops because nothing changes any more. Sounds boring to me! Show me the inefficiencies, and I’ll show you a business opportunity.

Good reading on this subject is:

Human Action, by Ludwig von Mises
Man, Economy, and State, by Murray Rothbard
Power and Market, by Murray Rothbard

choreplay's avatar

Thank you @maudie. Dude your talking about things that are complicated by free will and human nature. You would have to know everything and would have to sow up every element of risk including natural desasters. If possible your concept may be able to improve elements of supply and demand and that would work if there was not any greed in the world. Go back to the basic question of why capitalism works. I hope I’m wrong, keep thinking happy thoughts.

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