On Prices, Narr…

On Prices, Narratives, and Market Efficiency

 
The fourth anniversary of the Lehman bankruptcy has been selected as the release date for a collection of essays edited by Diane Coyle with the provocative title: What’s the Use of Economics? The timing is impeccable and the question legitimate.

The book collects together some very thoughtful responses by Andrew Haldane, John Kay, Wendy Carlin, Alan Kirman, Andrew Lo, Roger Farmer, and a host of other luminaries (the publishers were kind enough to send me an advance copy). There’s enough material there for several posts but I’d like to start with the contribution by John Kay.

This one, as it happens, has been published before; I discussed Mike Woodford’s reaction to it in a previous post. But reading it again I realized that it contains a perspective on market efficiency and price discovery that is concise, penetrating and worthy of some elaboration. Kay doesn’t just provide a critique of the efficient markets hypothesis; he sketches out an alternative approach based on the idea of prices as the “product of a clash between competing narratives” that can form the basis of an entire research agenda.

He begins with a question famously posed by the Queen of England during a visit to the London School of Economics: Why had economists failed to predict the financial crisis? Robert Lucas pointed out in response that the inability to predict a financial crisis was in fact a prediction of economic theory. This is as pure a distillation of the efficient markets hypothesis is one is likely to find, and Kay uses it to evaluate the hypothesis itself:

Read more: http://rajivsethi.blogspot.com/2012/08/on-prices-narratives-and-market.html

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