Booms ‘n’ Busts ‘r’ Us

Good letter to the FT from James Montier and Albert Edwards making mock of Andrew Lo’s proposed “adaptive markets hypthesis:

…The adaptive markets hypothesis (AMH) that Prof Lo proposes may seem superficially attractive, especially to economists who like to link their models to those of biological evolution. The idea of survival of the fittest seems to tug at the heart strings of economists brought up on a diet of competitive markets.

…As we understand it, the AMH provides a halfway house where sometimes markets are irrational and sometimes they are rational. We would argue that the amount of time that markets are rational is near negligible. Instead markets seem to be in a constant state of disequilibrium – moving from boom to bust and back again, rarely if ever stopping off at “normal”.

If markets were adaptive we would surely be constantly moving towards an equilibrium, rather than constantly overshooting in each direction. The excess debt that was built up during the so-called “great moderation” and which haunts the world was thought to be “normal” by those who denied the existence of bubbles, and our abilities to actually spot them ex ante (most especially the central banks).

…If, as one of us has recently argued (Insight, June 25), the efficient markets hypothesis is the financial equivalent of a dead parrot, then the AMH may be a dodo.

More here.