Here is an amazing spectacle. Everyone knows that the house must win and the players, over time, must lose. And yet casinos flourish all over the world. Nor, contrary to the standard arbitrage argument for efficient markets, does the smart money, the house, end up with all the capital in the world while the dumb money, the players, go broke losing the capacity to sustain inefficiencies in the market. To the contrary (and contrary to one of Jarrow’s assumptions) there is a continuous source of wealth for the house to keep winning; the dumb money is constantly replenished.

From the fantastic article: "How Big is Almost?: or why the finance professoriate is clueless about managerial effectiveness"

Stefan Jovanovich quotes from the paper: 

"The paradoxical notion that uncertainty is absolute, that randomness is an objective quality, first and foremost of nature but by extension of social and economic life as well, has been rampant in our time. It was at the heart of the Copenhagen debate over the direction of quantum physics. It drove Keynesianism and Marxism and Smith’s replacement of the entrepreneur with that invisible—but oh so heavy—hand. It drove centuries of absurd debate over the relative importance of “capital” and “labor” as if they were objective fungible commodities with capabilities separable from the particular capitalists and laborers who wielded them."

"(t)here are men who consistently hit the bull’s eye at 300 yards and men who never hit it once. There are baseball players who hit .300 over a career and those who ride the bench. There are engineers with dozens of important patents to their name and those who never amount to much. There are farmers who prosper year in and year out and those for whom the weather is always bad. And generally we say the successful shooters and hitters and engineers and farmers are “good” at their jobs and the unsuccessful ones less good. We do not generally say (unless we are feeling envious), “Oh, they were just lucky,” or “they were breaking the rules.”

Can securities markets be so special among all markets, among all the arenas of our experience that in them alone diligence and skill and judgment and even raw talent do not correlate with good outcomes?"

"Randomness or “incomplete knowledge” is a subjective phenomenon. Different observers will have more or less knowledge and more or less uncertainty as a result. Moreover we can gain knowledge by dint of hard work, natural talent, and sometimes luck. We can be well prepared or poorly prepared to make a decision, discover special relativity, or buy a security. Even our best efforts to increase our knowledge may be insufficient. We may know a lot but not quite enough. We may fool ourselves about our positive expectation. There is no guarantee that our search for knowledge will bring us close enough for success. But neither is there any basis for a dogmatic ssumption of failure—or futility."

"We celebrate successful investors with other successful entrepreneurs as risk takers. This is true in the sense that the successful investor, like the entrepreneur, routinely makes judgments in the face of uncertainty. Nevertheless, the essential job of both investors and entrepreneurs is to reduce that uncertainty. Successful investors make money not by accepting risk as a given, as Modern Portfolio Theory tells us to do, but by increasing their ****

chance of making good decisions as compared to the less informed, less diligent, less talented. Admittedly how good investors, or entrepreneurs, do this is not entirely obvious. Edison helpfully told us it was 99% perspiration and 1% inspiration, but he was distinctly unhelpful in explaining how we might come by that crucial 1%. The progress from the objective uncertainty of a coin flip to sound judgment or even inspired creation is only partly a matter of quantifiable factors like more research or better math. Psychology or character or knack or what you will play an enormous role. Ultimately it does seem to matter not only what the investor or manager or entrepreneur."

Easan Katir writes: 

This is the most articulate rebuttal of the random walk theory ever! Thank you for posting.

If the heat of debate contributes to global warming, then this long conversational thread alone may have raised the earth's temperature a degree or so.

Gary Rogan writes:

It still all comes down to how predictable and persistent someone's ability to outperform SOMETHING is. Whether or not the mathematics of price movements are distinguishable from brownian motion, which they clearly are, this whole never-ending argument is about whether outperformance is reliable enough to (insert your own criteria here, like "bet the house"). The world is a confusing place, for instance Victor seems to really like "Random walk down wall street" year clearly he does other things besides putting everything into some total world ETF. Even if someone has stellar history, how can you ever know that starting tomorrow they will be on a long losing streak that will either reverse all of their gains up to now or make them quit the game?






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