[ExI] Bitcoin

[Gordon]

Mirco Romanato <painlord2k at libero.it> wrote:


>>> You're describing investment schools of thought. I was talking about how dumb 
>>> money actually operates. These features are timeless.

>> Many economists would disagree that the concept of "dumb money" has any
>> meaning.

> In fact, who want "Smart money"?
> It would spend you instead of you spending it.

:)

On this subject, while it seems obvious to our intuitions that there must exist "smart money" and "dumb money" (savvy and not-savvy investors), it is difficult to identify either. Studies show that professional money managers who outperform the US stockmarket in year 1 are no more likely to outperform in year 2 than those who underperformed in year 1. In fact, after expenses, the majority of money managers underperform an unmanaged index fund, suggesting that expertise buys nothing after accounting for transaction costs.  

I do not believe the Efficient Market Hypothesis (EMH) is the final truth about the market, but it does nonetheless seem to be a close approximation of it. Significant anomalies are infrequent, and those which are common are relatively unimportant in practical terms. In many cases they can be explained with a broader definition of "risk".

For example, one study showed that small cap stocks traded over the counter offer a slightly better than average risk-adjusted return, an apparent anomaly to EMH. But what is a risk-adjusted return? According to EMH, risk is defined as beta (roughly speaking, the volatility of the asset price relative to the general market). Beta is not however the true and final measure of risk. It is merely a convenient proxy for it. In the case of small cap stocks, the spread between the bid and the ask prices are often quite high in percentage terms. These wide spreads represent a real additional risk not accounted for in EMH. It is very likely that after adjusting for this additional risk, the apparent anomaly disappears. 

I think the pursuit of alpha (returns in excess of the market, adjusted for risk) is an almost but perhaps not completely futile endeavor, at least in large highly liquid markets like the US stockmarket. Small emerging markets like that for Bitcoin offer better opportunities for alpha, at least in theory, as they are still in their infancy and probably not very efficient.

-Gordon
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