Today’s markets are dominated by computer-based trading and complicated algorithms that can profit from very small inefficiencies in the market over split second periods of time. Many argue that these computer systems have made outperforming the market considerably more difficult. Yale professor Robert Shiller looks at this argument in his latest article for Capital Finance International. Shiller looks at the recent book “The Incredible Shrinking Alpha”, which argues that ““the hurdles to achieving alpha [returns above a risk-adjusted benchmark – and thus a measure of success in picking individual investments] are getting higher and higher”, and examines whether alpha may eventually be eliminated by market efficiency. The issue with the argument of an efficient market, however, according to Shiller is that it does not explain the story-based fluctuations that occur on a regular basis in the market. Things like the large emotion-fueled swings recently in China and the fact that viral stories can significantly move the market seem to contradict that theory that the market has become completely efficient.
In the end, Shiller concludes that the market remains inefficient as it always has been. As Shiller puts it “Human judgment, good and bad, will drive investment decisions and financial-market outcomes for the rest of our lives and beyond.”