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The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World

Author

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  • Roger E.A. Farmer

    (UCLA Economics - UCLA - University of California [Los Angeles] - UC - University of California)

  • Carine Nourry

    (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique, IUF - Institut universitaire de France - M.E.N.E.S.R. - Ministère de l'Education nationale, de l’Enseignement supérieur et de la Recherche)

  • Alain Venditti

    (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique, EDHEC Business School - Département Comptabilité, Droit, Finance et Economie)

Abstract

Existing literature continues to be unable to offer a convincing explanation for the volatility of the stochastic discount factor in real world data. Our work provides such an explanation. We do not rely on frictions, market incompleteness or transactions costs of any kind. Instead, we modify a simple stochastic representative agent model by allowing for birth and death and by allowing for heterogeneity in agents' discount factors. We show that these two minor and realistic changes to the timeless Arrow-Debreu paradigm are sufficient to invalidate the implication that competitive financial markets efficiently allocate risk. Our work demonstrates that financial markets, by their very nature, cannot be Pareto efficient, except by chance. Although individuals in our model are rational; markets are not.

Suggested Citation

  • Roger E.A. Farmer & Carine Nourry & Alain Venditti, 2013. "The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World," Working Papers halshs-00796672, HAL.
    • Handle: RePEc:hal:wpaper:halshs-00796672
    Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-00796672
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    References listed on IDEAS

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World
      by Christian Zimmermann in NEP-DGE blog on 2013-03-16 00:50:06

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    Cited by:

    1. Campos Dias de Sousa, Ricardo Emanuel & Howden, David, 2015. "The Efficient Market Conjecture," MPRA Paper 79792, University Library of Munich, Germany.
    2. Farmer, Roger & Zabczyk, Pawel, 2016. "The Theory of Unconventional Monetary Policy," CEPR Discussion Papers 11196, C.E.P.R. Discussion Papers.
    3. Roger E.A. Farmer, 2016. "Pricing Assets in an Economy with Two Types of People," NBER Working Papers 22228, National Bureau of Economic Research, Inc.
    4. Farmer, Roger, 2013. "The Natural Rate Hypothesis: an idea past its sell-by date," Bank of England Quarterly Bulletin, Bank of England, vol. 53(3), pages 244-256.
    5. Thomas Hintermaier & Winfried Koeniger, 2018. "Household debt and crises of confidence," Quantitative Economics, Econometric Society, vol. 9(3), pages 1489-1542, November.
    6. Stefanescu, Razvan & Dumitriu, Ramona, 2016. "Particularitǎţi ale evoluţiei variabilelor financiare [Some particularities of the financial variables evolution]," MPRA Paper 73481, University Library of Munich, Germany, revised 02 Sep 2016.
    7. Beniamino Moro, 2013. "The Run On Repo and the Liquidity Shortage Problems of the Current Global Financial Crisis: Europe vs. The US," Ekonomi-tek - International Economics Journal, Turkish Economic Association, vol. 2(1), pages 41-77, January.
    8. Benjamin Keefer, 2016. "Sensitization and Extraordinary Persistence," Working Papers 2016-01, Carleton College, Department of Economics.
    9. Dmitry Plotnikov, 2014. "Hysteresis in Unemployment and Jobless Recoveries," IMF Working Papers 2014/077, International Monetary Fund.
    10. Roger E. A. Farmer, 2018. "Pricing Assets in a Perpetual Youth Model," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 30, pages 106-124, October.
    11. de la Torre, Augusto & Ize, Alain, 2013. "The foundations of macroprudential regulation : a conceptual roadmap," Policy Research Working Paper Series 6575, The World Bank.
    12. Roger Farmer, 2014. "Asset Prices in a Lifecycle Economy," NBER Working Papers 19958, National Bureau of Economic Research, Inc.
    13. Roger E. A. Farmer, 2014. "Financial Stability and the Role of the Financial Policy Committee," Manchester School, University of Manchester, vol. 82(S1), pages 35-43, September.

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    More about this item

    Keywords

    sunspots; extrinsic uncertainty; excess volatility; inefficient markets; heterogeneous agents; overlapping generations;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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