Efficient Market Theory

Fun Fact: The Nobel Prize in Economics isn't actually a real Nobel Prize, no matter what the disciples of the Chicago school of economics want you to think!

Warren Buffett Quotes About Efficient Market Theory

In 2006, Warren Buffett quipped, in his annual letter to shareholders: "Typically, a finance instructor who had the nerve to question EMT had about as much chance of major promotion as Galileo had of being named Pope".

Here's another one of his quotes, this time from 1988:

"Efficient market theory" (EMT) […] became highly fashionable - indeed, almost holy scripture in academic circles during the 1970s. […] Observing correctly that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient. The difference between these propositions is night and day.

See Also: buffettportfolio.com

Academics, however, like to define investment "risk" differently, averring that it is the relative volatility of a stock or portfolio of stocks - that is, their volatility as compared to that of a large universe of stocks. Employing data bases and statistical skills, these academics compute with precision the "beta" of a stock - its relative volatility in the past - and then build arcane investment and capital-allocation theories around this calculation. In their hunger for a single statistic to measure risk, however, they forget a fundamental principle: It is better to be approximately right than precisely wrong. For owners of a business - and that's the way we think of shareholders - the academics' definition of risk is far off the mark, so much so that it produces absurdities. For example, under beta-based theory, a stock that has dropped very sharply compared to the market - as had Washington Post when we bought it in 1973 - becomes "riskier" at the lower price than it was at the higher price.

Source: Warren Buffet (1993)

Tens of thousands of students were therefore sent out into life believing that on every day the price of every stock was “right” […] After all, if you are in the shipping business, it’s helpful to have all of your potential competitors be taught that the earth is flat.

Source: Warren Buffet (2006)

Witness the tenacity with which almost all clung to the theory of efficient markets throughout the 1970s and 1980s, dismissively calling powerful facts that refuted it “anomalies.” (I always love explanations of that kind: The Flat Earth Society probably views a ship’s circling of the globe as an annoying, but inconsequential, anomaly.)

Source: Warren Buffet (2010)

Speaking of Thorp’s Beat the Market, Warren Buffett observed:

In other words, the market always knew everything. […] Observing correctly that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient. The difference between these propositions is night and day.

Source: Wesley R. Gray and Tobias E. Carlisle. Quantitative Value: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors. John Wiley & Sons, 2012. [B102]

Warren Buffett is quoted as saying: "I’d be a bum in the street with a tin cup if the markets were efficient".

Source: Paul Wilmott. Frequently asked questions in quantitative finance. John Wiley & Sons, 2010. [B112]

See Also: buffetttribute.com (upcoming)

Another quote from Buffett on EMT: "The authors spoke of the 'discovery' of efficient markets as though the theory had been a natural element awaiting its Marie Curie". And this same wonderful biography:

The only factor necessary to calculate the expected relative return on a stock was its beta. Nothing about the fundamentals of a company mattered; the one number, beta, computed from past stock prices, was the only relevant issue. […] Risk, then, equaled price volatility.

Source: Roger Lowenstein. Buffett: The making of an American capitalist. Random House, 2013. [B220]

[Buffett] also noted that during the panic, different bonds of the same issuer yielded anywhere from 6% to 11% at the same time! So much for the efficient market. [...] Berkshire acquired $4 billion of municipal bonds during the period. [...] Hedge funds had to dump because of margin calls. [...] Like men spear fishing, you may wait a long time, and when opportunity comes, you must act.

Source: Daniel Pecaut and Corey Wrenn. University of Berkshire Hathaway: 30 Years of Lessons Learned from Warren Buffett & Charlie Munger at the Annual Shareholders Meeting. United States, Pecaut, 2017. [B221]

See Also: buffettstrategy.com