Smarts, luck, wealth

Reuters blogger Felix Salmon wrote Tuesday:

A tweet from Joe Weisenthal yesterday, on the subject of Annie Leibovitz, is I think revealing of a particularly American mindset: call it the Wealth Corollary of the Efficient Market Hypothesis. In a nutshell, it says that if you’ve made lots of money, you must be pretty smart.

Isn’t that totally wrong?  Under the efficient market hypothesis, if you’ve made lots of money on the market, you must be pretty lucky. (Whether it takes smarts to make lots of money as an art photographer, or a baseball player, or a breakfast-cereal magnate, is surely outside the scope of the EMH.)

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3 thoughts on “Smarts, luck, wealth

  1. I agree, at least with the strong form of the EMH which say that there’s no strategy which consistently allows you to beat the market as a whole.

  2. Anonymous says:

    It depends on how exactly one states the EMH. It’s compatible with at least some forms (although you’re right that it’s incompatible with others). I think the idea is this. The strong EMH doesn’t say there’s no possible way to beat the market, but rather that the market prices optimally take into account all the information available to the investors. If you run across some insider information that hasn’t leaked out to anyone else or been taken advantage of by any other insider yet, then you might be able to use it to beat the market. Being really smart could count as something like insider information. If you, say, just intrinsically had a much keener feeling for business cycles than any other investor on the planet, you could take advantage of that private knowledge to make a fortune, until you grew so wealthy that your actions were substantially influencing the market. In practice, being smart isn’t a realistic route to wealth (except perhaps for Jim Simons), but in principle the EMH allows beating the market if you know or can figure out something nobody else knows yet.

    In any case, it’s tricky to state the EMH precisely, since you can go pretty quickly from forms which are insufficiently powerful to conclude anything concrete to forms that are clearly false in the real world.

  3. shmuel says:

    The EMH doesn’t contradict the possibility of making money by smartly providing goods and services that people want; it stops you from making (too) much through investment.

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