Bitcoin and the Efficient Market Hypothesis

[Braden]

So I was thinking about how the Efficient Market Hypothesis applies to the increase in Bitcoin prices.

Simply put, the EMH states that if a rational actor thinks that a trade-able asset will increases in value in the future, he will buy that asset at any value less than what he expects it to rise to (less transaction fees and expected inflation). If that information is known to the market generally, then "tomorrow's price will be reached today" as a consequence.

Given the rapid rise in price I am having trouble reconciling this. The market knows the future quantity of bitcoins and knows to expect increasing publicity. What new information is entering the system to drive price increases? Or is it being driven entirely by irrational exuberance/greater fools type speculation?

[goatpig]

What new information is entering the system to drive price increases? Or is it being driven entirely by irrational exuberance/greater fools type speculation?

It isn't new information, it's new investors that have acquired that information. You should work on the assumption that anyone who is already part of the market invested as much as they feel comfortable to, according to your theory. On the other hand, the Bitcoin market hasn't reached full load yet, nowhere near that actually. Let's say it has achieved less than 1% of its user base as of today.

[Braden]

If people already involved know that new people will enter (which they clearly do) then they should purchase more bitcoins on the basis of that assumption. If they are uncomfortable investing that amount, that means the market thinks bitcoin has a substantial chance of failure.

[goatpig]

that means the market thinks bitcoin has a substantial chance of failure.

Indeed they could be. You don't mind driving at 100mph on the highway, but however large the road is, if it bordering a cliff with no fence, you wouldn't be speeding quite as much. Uncharted territories sure are scary.

This is also a case of common sense. It is proper practice to not invest your rent and grocery money. As I said, from your own theory, you should assume everyone that invested in Bitcoins put as much money in it that they could afford, based upon their expectations of profit vs potential loss. It is madness to expect only profit and no possible loss. But I guess if you feel comfortable with selling your house to buy BTC, you can go ahead, no one will stop you.

Lastly, the knowledge about adoption isn't absolute. Exponential adoption is expected, but the time frame remains an unknown element.

[kinghajj]

Simply put, the EMH states that if a rational actor...

Given the rapid rise in price I am having trouble reconciling this. The market knows the future quantity of bitcoins and knows to expect increasing publicity. What new information is entering the system to drive price increases? Or is it being driven entirely by irrational exuberance/greater fools type speculation?

The assumption that a market is full of "rational actors" is faulty. Scientific studies show that humans are anything but rational when making economic decisions (these errors in judgement are currently thought to be caused by evolutionary holdovers, so these behaviors were in fact rational in the past, but no longer in the present). Any analysis that ignores (or, indeed, asserts the exact opposite of) these facts is unlikely to be very helpful.

[DATA COMMANDER]

The efficient market hypothesis has always struck me as completely absurd.

[benjamindees]

It is somewhat absurd in the context of any modern economy.  But in the absence of force or fraud, markets tend towards efficiency.

[Braden]

I am well aware that people do not always act as rational decision makers. Indeed, since I'm currently studying behavioral economics I'm quite versed in the topic. However, rationality assumptions are a useful approximation to describe long term behavior.

The reason I find this interesting is that if price increases can be justified in a rational framework it is less likely to be an unsustainable bubble. Otherwise, we must assume that irrational exuberance is the driving force in the bitcoin economy, which does not say good things about its future stability.

[Explodicle]

I think it's risk aversion. I don't know about you guys, but I'm scared to buy too much more Bitcoin in case the whole thing disappears tomorrow for whatever reason. I tell my friends that they should all buy some Bitcoin but not more than they can stand to lose. As more people buy in, others grow bolder, so they buy in... I doubt it will last too much longer. Eventually there will be arrests, more DDOS attacks, bugs discovered, and Bitcoin will be tested. If it survives, the value might become more predictable.

But I'm no behavioral economist and could be completely wrong. This is not financial advice, please don't act on this post and sue me when the bubble bursts, yada yada...

[FooDSt4mP]

Bitcoins will need to be tested to gain more trust.  That is true.  There are far more transactions now than a few months ago, so the velocity is increasing.  What these transactions represent, we'll never know.  But I can tell you my second box of food I paid for with bitcoins is on it's way.

[hugolp]

The problem is not with bitcoin, its with the Efficient Market Theory, that is basically wrong.

Dont get me wrong, markets are efficient, just not in the way described by the Effcient Market Theory.

[Braden]

In what way?

[hugolp]

In what way?

The Efficent Market Theory is not a theory that describes reality. It can be used for some specific cases where the conditions are very close to the conditions required by the EMT. But in general the EMT does not hold.

According to the proponents of the EMT bubbles should not even happen. Eugene Fama, one of the most famous proponetnts of the theory, has denied that bubbles exists. Go figure.

[tymothy]

What new information is entering the system to drive price increases? Or is it being driven entirely by irrational exuberance/greater fools type speculation?

It isn't new information, it's new investors that have acquired that information. You should work on the assumption that anyone who is already part of the market invested as much as they feel comfortable to, according to your theory. On the other hand, the Bitcoin market hasn't reached full load yet, nowhere near that actually. Let's say it has achieved less than 1% of its user base as of today.

I think you're dead on. The Efficient Market Hypothesis assumes that everyone has the same information available to them and hence the price responds immediately to match that information. Most people are not aware of the existence of bitcoins.

[evoorhees]

The Efficient Market Hypothesis should not be regarded as a "fact" but more as a "tendency."  Markets always tend toward efficiency, but are never full efficient, nor operating on perfect knowledge.

Even though the general bitcoin market knows that new publicity will bring in more buyers, you're assuming actors will want to buy bitcoins ahead of this publicity. But, this is risky, because nobody knows the perfect extent of the publicity.

[Hal]

Every day that goes by and Bitcoin hasn't collapsed due to legal or technical problems, that brings new information to the market. It increases the chance of Bitcoin's eventual success and justifies a higher price.

[cartman]

i think the bitcoin market is pretty much efficient. remember, that the value of bitcoin is, amongst other parameters, dependent on a very little chance to very high values - when it takes over the world this is one very volatile parameter, so the rally is not a strong argument against the EMH.

[FreeMoney]

Are you saying you don't understand why time is required for information to get into the market price 

[gold969]

  it's absurd, but the time machine would be the way)) only 7 years, and what changes ...


 

Every day that goes by and Bitcoin hasn't collapsed due to legal or technical problems, that brings new information to the market. It increases the chance of Bitcoin's eventual success and justifies a higher price.