Are markets efficient?

??????????????? Investing can be a tall task, especially when you don’t know where to start. In most cases, investment managers start by profiling an individual, their liquidity needs, risk tolerance, and capacity to invest, among other things. One set of standard portfolios created for the individual is based on the Modern Portfolio Theory. Among other assumptions, the article of Aaron Brown investigates one of the most essential elements of the theory, that securities prices can be mathematically explained or simply that markets are efficient enough to input into a mathematical model for prediction.

??????????????? Mr. Brown argues that Markowitz did not look for economic understanding but algorithmic expansion. Markowitz is an avid mathematician and programmer, and in his classes at UC San Diego, he enthusiastically taught mathematics and algorithms. The old vanguard scrutinized his work, believing it was a new way of “investing” and called his work not a study but “gambling “(Aaron Brown).

??????????????? Aaron argues that after the theory escaped Markowitz, economists picked it up and developed the Modern Portfolio Theory. Then, many forward-thinking investors took it and created the CAPM risk identification and management model. Before these new forms of investing, the most prominent form was the Prudent Man Theory, where the losses are not considered mathematical but as severe as a crime. As an individual would not scuff off an accident, arguing that the rest of his driving was perfect and this was just a law of numbers, the argument was that losses were from lack of prudence and gambling. An investor could be found liable for fraud for this kind of investing.

??????????????? Personally, I see the comfort in the Prudent Man Theory, but if I were, at that time, saving myself from the risk of liability, I would probably take the approach of the CAPM and MPT because of statistics and the law of numbers. Picking up on the idea of accidents, when driving alone on an empty road, the likelihood of an accident is exclusively at the driver's discretion. Are they tired and falling asleep? Do they get distracted? Do they pull out their phone? But in the context of a large city, the law of numbers and relative size makes a huge difference. Driving one day from DT LA, my Epidemiology Supervisor, whom I was carpooling with, asked me why I tended to stay in one lane. My reply was: I remain in one lane because the more I shift from lane to lane, the greater the area that my care takes, and the easier it is to become a “target” in the event of an accident. If I remain in my lane, the risk only becomes those behind me, in front and immediately next to me, in that they interact with my lane.

??????????????? The idea was that even if I extrapolated farther from the immediate individuals, my ability to change my risk of accidents by remaining in one lane was more significant than when I moved lanes, as the more I drive in a congested highway, the greater the likelihood that I will be involved in an accident. Otherwise known as the law of numbers.

??????????????? I disagree with the MPT that markets are efficient; I believe they are highly inefficient, and as the Prudent Man Theory dictates, I need to be prudent with my investments. However, understanding the variable market, my returns are based on the law of numbers. A company may be stellar, but if liquidity is lacking or investors are not interested, it may remain in a long-term downward trend. We see this with many safe companies. Yet, others that seem overvalued, lacking in profitability, but “making it up” in growth see much more attention and stock price growth. It is speculative, but one can yield high returns when one knows how to navigate choppy waters. The law of numbers exists here if boats are bound to capsize and sink in choppy waters for long.

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Aaron Brown, Nobel Laureate Harry Markowitz Was a Misunderstood Economist - Bloomberg