Honestly - stuff like this reinforces a feeling I have had recently that the social sciences are nothing more than pseudoscience dressed up most of the time.
Economists have essentially no idea what is going on and neither do their financial compatriots and the EMH is by far the clearest example of this.
I'm trying to make it a personal rule that anything outside of the hard sciences (math/physics/chemistry/statistics etc) is bullshit to me until further notice.
I mean really - I do advanced math and statistics in moderately complex systems - AI/robotics - and I can barely wrap my head around them. I shake my head in disgust at those who apply platonic and unrealistic theories to the extremely complex system that is the world. Indeed, the surety they display in their theories amuses me, because to even think that one can reason about the entire world all at once is, in fact, hilarious.
This kind of armchair criticism is not particularly enlightening, or productive. You can still make useful and largely correct predictions without understanding all of the dynamics in a system.
After all, all science amounts to an approximate model, even your vaunted "hard sciences".
To put it bluntly, the universe is not sneaking around behind your back and trying to exploit any hole in your models it can find. Businesses and the financial marketplace do exactly that with economic models.
Not this. Unless we have explicitly and fairly advanced education, and are disciplined enough to apply it to all we do, we - the human species, every single one of us - suck at statistics, are terrible at understanding or predicting the behaviour of complex systems.
Read Kahneman's "Thinking,Fast and Slow" to get a better idea as to why.
Our biological heritage has left us - oh, OK, the vast majority of us - fundamentally incapable of understanding complex systems and making predictions that have any value beyond the immediate short term. Our intuition - our System 1 heuristics (read the book) - is completely ill-suited to this, and our reason - System 2 (ditto) - doesn't fare much better without advanced training.
Kahneman and others also cite many cases where trained experts make the same errors of judgement and analysis as the rest of us when they stray even fractionally from their areas of expertise.
The GP is right: We get a lot more of this "soft stuff" wrong than we get right because we generally don't bother to apply hard science methods to the problem.
Personal anecdote: I stopped listening to the news because I used to work in crypto. Well, that's the tl;dr reason.
I worked for a company that did PKI and noticed that tech journalists, who might be expected to at least have some greater technical background than just folk made egregious errors in their reporting, in reports that were researched and drafted and edited and considered and fact-checked prior to publication.
While PKI is complicated, it is not complex. Not like the economy. So if these "specialized" journalists with a technical leg up could get so much of something so simple so wrong, what were folks with degrees in English and/or journalism doing to something as advanced and out of our grasps as the economy?
Truth be told, I haven't stopped reading the news - I read it differently. Should an interesting headline catch my eye, I look for a few more. The more interesting the story, the more sources I check/read before accepting to learn anything from the reporting. This is a necessary side effect of how complex the world and its news are, and how simplistic reporting is.
Economists had no idea why their theories of rational actors were so flawed (but flawed they knew them to be) until Kahneman and Tversky came along. Hard science can only cast light on the dismal and dark, and the dismal and dark will remain so, will remain largely speculative, until they adopt our tools.
I do the same. I try to make sure new interesting models of the world are kept at arms length until I've at least tried to fully understand it myself. I'm still free to use them as black boxes but I always remind myself that they are subject to catastrophic failure at any point in time.
I'm sorry but were you alive during the last couple hundred financial crises?
I mean if your entire field is dedicated to predicting the future of finance and economics and you don't predict them - it kind of shows that you really don't know what you are doing.
All I'm doing is pointing out that the social sciences have no clothes on.
"I mean if your entire field is dedicated to predicting the
future of finance and economics and you don't predict them
- it kind of shows that you really don't know what you are
doing."
I thought the field of finance and economics was about how, unless you have something other people don't, market prices cannot be predicted?
right....because the field of math has never changed course (see: Godel), nor physics (see: Newton, Einstein, )...
You're reading too much into the disproportionate effect mistakes in economics have had on society. Science get things wrong all the time...failure is part of the learning process.
I don't understand how the field of math can change course. I mean Hilbert, Frege, Church had an idea that turned out to be infeasible. But the field in general continued and has not been affected much by that goal nor the consequences of Godel's theorems. In mathematics there is no where in particular we want to go to. This notion of course changing is thus something I am having trouble placing.
As for physics. The idea of not changing course is exactly what sets apart good theories from bad. If you have a new theory and it does not include the old at a limit then it is a good sign that you are doing something wrong. Newton was not wrong, just inaccurate. Einstein did not invalidate Newton, only corrected the extreme cases.
True but at least the hard sciences modify after being falsified.
The social sciences don't have to because they aren't based on the scientific method - mainly the design and independence of repeatable experiments with controlled variables.
Hard science equations have no room for bullshit whereas the social ones do - hence EMH is still taught.
The social sciences don't have to because they aren't based on the scientific method - mainly the design and independence of repeatable experiments with controlled variables.
The same is true of many physical sciences - geophysics, oceanography, climate science, astronomy, etc. Your criticism applies to basically any scientific theory which has poorly understood microfoundations (i.e., a lot of them).
The EMH is taught because it's a useful approximation to reality, even if it's imperfect. Or, as the article puts it: Whether markets are efficient or not, and whether P = NP or not, there is no doubt that there will be markets that can allocate resources very close to efficiently and there will be algorithms that can solve problems very close to efficiently.
Incidentally, the EMH claims that financial crises are unpredictable. So the lack of useful predictions of the financial crisis is evidence in favor of the EMH.
[edit: Note, in response to Dn_Ab that 3SAT, the problem considered by the paper, is NP complete.]
But he is not, in that quoted statement saying much. For example, if the problem is NP-Hard but not NP-Complete then we will not even be able to tell how well we are doing.
Or for markets, aspects of it may invovle solving NP-Hard problems with efficient approximations that are themselves NP-Hard (you are better placed to opine on whether such a possibility is likely).
I don't know. We've seen the idea of rational agents in economics go away, right?
Also...I'm not an economist so I don't really know what's going on in this area...but maybe EMH is still being taught because it's the best model we have at the moment?
Are you sure it's being taught everywhere? Maybe some places have already dropped it? Change takes time.
Honestly - since your profile advertises "Calling out bullshit in your own thinking and everyone else's is a very important skill."
Let me help try help you out :). Here are some more of your quotes:
'Everyone is ruled by incentives'
'If it's a derivative of a psychological bias <...>'
Rather strange to be making claims involving incentives and psychology, for someone that rules everything outside the 'hard sciences' as bullshit.
(FWIW I studied math, cs, applied math and physics at varsity but learned a great deal of knowledge that corresponds well with reality, outside of those fields)
Did you edit your reply? Not sure, but I suddenly read my rebuttal and I sounded like a dick, so I toned it down. Sorry - unusually cranky this morning :)
The article is quite probably BS as you point out, and I have no idea.
However keeping an open mind seems like a worthy goal, irrespective of the BS that goes on in any field and even if the social sciences do tend to be less empirically rigorous.
And while it's exceedingly complex, there are indeed some people (albeit a precious few), that understand how the economic machine works. Ray Dalio is one such example.
I wouldn't say that economists have no idea about this, or that their theories aren't useful. No falling object you'll ever encounter actually matches the equation h = h0 - (1/2)gt^2 perfectly, but the equation is still useful. If the efficiency of a market is limited by computational constraints, well, we already knew it was limited by transaction costs, so while this finding is interesting it doesn't change how we should view the world.
>"Economists have essentially no idea what is going on"
Complete and utter nonsense. "You" don't know what's going on, and assume others don't. The public is unbelievably ignorant of this subject. These men are brighter than you think.
>"EMH is by far the clearest example of this"
EMH is a 50 year-old theory. Like practically any other subject, economics that is taught in school at low-levels is based on old science. There is real, modern research happening on real-world things, just go poke around the Fed's site to see what they're doing.
EMH is actually a hypothesis (not a theory) that arises from non-arbitrage models. It's not meant to describe the real world, although it's thought-provoking to look at how "efficient" real markets are, so people like to characterize and "test" the EMH in its various forms. How markets fail to be "efficient" is often quite instructive for practical purposes.
For pedagogical purposes, I think it's a really good simplified and ideal illustrative model, until you learn the more axiomatic derivations of no-arbitrage (the arrow-debreau stuff). From your other posts, I gathered that you're not beyond undergrad studies in economics - you'll likely learn about the more complex models when you reach a more advanced and rigorous stage, if you pursue the theoretical path.
If I were you, I wouldn't be too concerned about others arguing about the EMH - without the proper foundations, you won't understand them beyond a superficial level.
Not to mention that it's popular for the less educated to bitch about the EMH, probably because it's an English acronym with commonly used words. I've almost never heard laymen talk about how unrealistic the nash equilibrium is (:
>"I've only done graduate level courses in economics and finance. If they know what they are doing why do we still have financial crises?"
Then you're ahead of me education-wise; we lend money until the default rate gets above a threshold, which causes a "crisis" of deleveraging. Then we lever up again. All of this happens around a long-term, upward growth trend. It's the business cycle. It's hard to time, but most people understand how it works.
How can you prevent crises when their foundations can come from anywhere, including natural disasters? It's impossible. But the powers-that-be do their best to soften the blow. And they have been very successful in this last recession. I know it's hard to convince people that it could have been worse, but it could have been worse.
Already they're working on the next problem: how do we not become Japan? Unlike some of the hard-sciences, economists get one kick at the can. If they miss, they have a new problem to solve.
Why not counter cycle the lending activity instead of exacerbating the business cycle?
Oh wait we're economists - free markets are sacrosanct and they are efficient - if there is an arbitrage opportunity to short surely the rational investors will price it correctly. Not.
>"Why not counter cycle the lending activity instead of exacerbating the business cycle?"
That's easier said than done. Most of it is politics. But they do.
The Fed began tightening monetary policy back in 2004, when rates went from just below 2% to 5.5%. They did so to start to "cool" the economy, and it essentially popped the housing bubble.
Did you include the "sic" as a joke? If so well played my friend, if not the streak continues. Including "sic" is grammatically incorrect because you are not transcribing an error or misspelling something on purpose.
I believe you to be mistaken. I did not include it as a joke, and using "sic" in this context is literally correct. The reference is to "Muphry's" law (carefully note the spelling), and almost everyone would assume that I had mis-spelled that, intending instead "Murphy's" law. Using "sic" indicates that it is written as I intended.
Quoting Wikipedia:
The Latin adverb sic ("thus"; in full:
sic erat scriptum, "thus was it written")
...
The usual purpose is to inform the reader
that any errors or apparent errors in the
transcribed material do not arise from
transcription errors, ...
But others, who do not read as closely as you apparently do, need the extra information provided by the "(sic)". More than once when quoting Muphry's Law I've been "corrected".
"Economists have essentially no idea what is going on and
neither do their financial compatriots and the EMH is by
far the clearest example of this."
You only learn about EMH in first or second year in university; It is debunked in later years. It's like how you get taught first newtonian physics then later on when you're taught relativity, you learn that newtonian physics is not quite right but for many cases it is a good enough approximation.
"I shake my head in disgust at those who apply platonic and
unrealistic theories to the extremely complex system that
is the world. "
That is unfortunate. Markets are extremely interesting to study. A market is a powerful machine very good at resource allocation. It is the third example of how simple interactions can give rise to computational power. The first two being "evolution" and "the turing machine".
It's not quite behavioural finance but marginal benefits and marginal costs as applied to market efficiency.
From the author of the EMH in 1991, 21 years after proposing the EMH.
"A weaker and economically more sensible version of the efficiency hypothesis says that prices reflect information to the point where the marginal benefits of acting on information (the profits to be made) do not exceed the marginal costs (Jensen (1978))."
http://efinance.org.cn/cn/fm/Efficient%20markets%20II.pdf
I admit to little knowledge of economics, but to me it seems as complex a system as weather, without the underlying physical certainties.
My reading of Fama and Mandelbrot seems to indicate that markets are essentially random and unpredictable. Being largely uninformed on the matter, though, I would appreciate any explanation of Mandelbrot's theories and their relevance to the topic at hand, as they seem to have been largely ignored by economists -- I could not speculate as to why.
To me the tools of chaos theory seem apt to describe markets, insofar as they may be described. If they happen to yield no useful results, I would believe that such may not be obtained. I would appreciate correction on this matter.
This stuff shows absolutely nothing. The author misrepresents what an efficient market means and then "proves" a tautology about it. (see my other comments, but it basically erroneously understands an efficient market to be one which knows everything that is knowable about the past, and then shows that that must include NP-hard problems.) Whether economics has any merit or not is a different issue, but this paper proves absolutely nothing.
To me stuff like this actually shows how some hard-science people apply autistic-like literal interpretation even to things that do not lend themselves to literal, narrow, interpretations. I'm sure, though, that many hard science people can expand their horizons enough to absorb different kinds of knowledge, too.
But the author claims that something is equivalent to P=NP! Now, P=NP does have a very "literal, narrow interpretation" (read: it has a very precise meaning), in fact, this is the only interpretation in which it makes sense at all.
So if you claim that something is equivalent to it, you better be prepared to define what exactly "something" is, and give a rigorous argument as to why it's equivalent. Some hand-waving with vaguely defined and ambiguous terms just doesn't cut it.
I have to agree. The author hasn't dealt with all the unsolved problems with bounded rationality, which quite frequently involves the inability to compute the future (the case where even if perfect information is available). Then, somehow, he "models" the cost as computational complexity, of a particular sort. But that's why we have peer reviews.
He interprets the definition of an efficient market as one that immediately represents all that is theoretically knowable about a security by the present time. Using this literal interpretation, everything that is knowable includes solutions to NP-hard problems. In fact he could have used it to show much more. If the price represents all that is knowable by the present time, than that means than not only all information is processed in zero time, information must travel instantly. He could have just as well claimed that for markets to be efficient information must travel faster than the speed of light.
The definition of an efficient market actually means that that the price of a security at time T represents all that market players can deduce about its history by time T, using information travel and processing speeds that market players possess. It really just means that everything that is historically known about the security can and will be used to determine its price as fast as possible. If it isn't possible - it won't determine the price.
Economists have essentially no idea what is going on and neither do their financial compatriots and the EMH is by far the clearest example of this.
I'm trying to make it a personal rule that anything outside of the hard sciences (math/physics/chemistry/statistics etc) is bullshit to me until further notice.
I mean really - I do advanced math and statistics in moderately complex systems - AI/robotics - and I can barely wrap my head around them. I shake my head in disgust at those who apply platonic and unrealistic theories to the extremely complex system that is the world. Indeed, the surety they display in their theories amuses me, because to even think that one can reason about the entire world all at once is, in fact, hilarious.