The Limits of Arbitrage

Wow, it’s already Friday. I’ll feel that I’ve short-changed you if we don’t do some Finance Theory before I go.

Did you see this roundtable about the state of macroeconomics in The Economist’s Free Exchange? Fascinating stuff; in particular it became a bit of an odd defense of the Efficient Markets Hypthosis (EMH). A representative comment was made by William Easterly, in defense of EMH:

The most important part of the much-maligned Efficient Markets Hypothesis (EMH) is that nobody can systematically beat the stock market. Which implies nobody can predict a market crash, because if you could, then you would obviously beat the market. This applies also to other asset markets like housing prices.

This is not true, and I want us to walk through why it isn’t. In March of 1997, Andrei Shleifer and Robert Vishny published a paper titled The Limits of Arbitrage (pdf) in the Journal of Finance. I think it’s the most important finance paper of the past 15 years, something everyone even remotely connected to financial markets should become familiar with. It builds on and summarizes a decade long research project, research they conducted with people such as Joseph Lakonishok and Brad Delong. In it they say that arbitrageurs, the very smart and talented traders at hedge funds who will take prices that are out of line and bring them back into line, making a good fee and making prices reflect all available information, the very building block necessary for EMH to work, can’t do their job if they are time or credit constrained. Specifically, if they are highly leveraged, and prices move against their position before they return to their fundamental value – if the market stays irrational longer than they can remain solvent – they’ll collapse before they can do their job.

And sure enough, a year later in 1998, Long Term Capital Management, very smart highly leveraged arbitrageurs, found themselves in a situation where prices moved away from them, and they had no capital with which to keep themselves afloat, just like Limits Of Arbitrage predicted. (This is the standard narrative in finance research seminars; it also appears this way, correctly, in Justin Fox’s The Myth of the Rational Market, a very excellent book that gets these details correct.)

There’s an argument that says “If the market is inefficient, why aren’t you rich?” This gives us the framework to understand why markets could deviate from true value but there isn’t a way to capitalize on bringing them back to true value – sometimes there is risk inherent in arbitrage, and sometimes there are situations where it is difficult to get on the other side of a trade. And specifically, it’s risk that isn’t compensated.

Here’s an example of how this works. Let’s say something is trading at $5. You are positive it is going to reach $10. Positive. It must. No chance it won’t at some point in the future. So you buy it, telling your boss/manager/investors you are going to make $10-$5 = $5 for free. But the price goes to $2.50. What happens? You should buy a lot more. Now you are going to make $7.50! However your boss/manager/investor thinks you are insane and have lost them all kinds of money, as they now have half of what they gave you, and wants to pull your trading funds – if you sell then, you lose money, and put downward pressure on the price. Also, depending on how you were leveraged, you may also be bankrupt. That’s how this works.

This gives us a guideline for figuring out how markets can get out of alignment with value – if it is difficult to attract arbitrageurs, who are necessary to keep prices in alignment, we should expect the market to have prices that are more prone to manipulation and bubbles. What attracts arbitrageurs? The bond market – it is easy to calculate the value of a bond, and easy to realize the value quickly. Foreign exchange markets – it’s relatively easy for arbitrageurs to go after central banks attempts to maintain nonmarket exchange rates.

What doesn’t attract arbitrageurs as easily? The stock market. The absolute and relative value of a stock is harder to estimate, and it may take a long period of time to realize your gain. (If you are comfortable with the terms, expected alpha doesn’t increase in proportion to volatility if volatility includes fundamental risk – read the paper, it’s excellent!) And though it isn’t covered in the paper, housing.

There’s no real way to go short housing. You can go short the bank issuing mortgages, but if the bank has two internal businesses – jumbo subprime loans and boring small business loans – might it not be sensible for them to turn down the business loan division in response to the market shorting? You need to be able to exert price pressure directly onto the market itself – the more intermediaries, the more likely it is your signal is converted into noise. There’s talk about how in the future we’ll all trade derivatives contracts on each other’s neighborhoods; depending on how that’s implemented, it would be something to say “I want to go short Detroit and Peoria in my portfolio.” Is there moral hazard to drive down those prices then? And life would be more interesting if the investment firm of “My Ex-Girlfriends LLC” could take out a derivative insurance contract that pays out to them if my house burns down over the next year. Thankfully that market is still some time away, if it ever gets here, so we can iron out the difficulties.

There’s a lot more research to be done here, but contrary to popular belief we do have an intellectual framework to know how markets can get out of whack, one that takes the EMH are brings it to a reality where we face actual constraints over scarce resources such as time and capital.

21 responses to “The Limits of Arbitrage

  1. So for EMH to work with arbitrage:

    1. You have to be your own boss with control over the necessary capital.

    2. It has to be a fairly small market with few intermediaries.

    3. Even then, to abuse the much-abused metaphor, you’re still up against something like the uncertainty principle.

  2. It’s even easier than that. You can predict a crash with 100% confidence if you proactively cause that crash or know that others are doing it.

  3. Even more crudely, the idea that movements in financial assets are not sufficiently predictable for anybody to be able to beat the market on average, after taking into account transaction costs etc., does not tell us that we should not expect academic macroeconomics to be better at identifying sources of macroeconomic danger than they were. I really don’t know what Easterly was thinking.

    How does that argument work – let’s say you are worried about current account deficits and fiscal deficits etc. in a hypothetical country, and are predicting a currency crisis and other painful adjustments. Would Easterly say that crisis are not predictable, therefore if people are predicting a crisis it cannot happen, by definition? Could nobody have seen the Argentinian currency crisis coming?

  4. Just out of curiousity what is “fundamental value” or “true price.”

  5. EMH is all nonsense. Soros explained it best: markets have thinking participants who are always biased. His track record makes it clear you can beat the market, which is not about ‘value’ but about psychology.

    Of course, you can lose too, which makes playing with your own money somewhat dangerous.

  6. To say that the EMH can be “fixed” simply by applying structural Time/Liquidity constraints is begging the question…

    You are merely saying that arbitrage in the Stock Market is restricted because there is insufficient arbitrage in the Credit Market. But saying that EMH in one market fails because of structural factors that are caused by failures in the EMH in another market is a circular argument!

    You are effectively saying EMH would work perfectly in the stock market if only we had more time/liquidity. BUT, the reason we don’t have more liquidity is because EMH does NOT work in the credit markets.

    And since stories are better than facts, here’s a story:

    Let’s say there’s a brilliant person – who knows exactly where the market will be in 5 years, but not in 5 months. Let’s call him Baron Wuffett. Even if Baron Wuffett had a 40 year history of successfully showing skill at outmaneuvering the market in a 5 year time frame (say, earning 20% returns vs. 7% over the course of 4 decades), he may not have accumulated enough capital to substantially move the market. One might presume that Baron Wuffett could _borrow_ that money, but that borrowing requires the EMH be extended to Capital Markets. And even with Baron Wuffett’s reputation, there are those who look at the rest of the market as smarter than any single individual could possibly be, and therefore deny him credit (even if he wanted to leverage himself up, which a very smart Baron Wuffet would not precisely because he knows that Credit Markets are not rational and he doesn’t want to be caught in a liquidity trap).

    Some people, who observe Baron Wuffett losing money in the short term might even declare that he has “lost his touch” or “lost his groove”. Or maybe he’s a doddering old fool.

    I don’t know if the issue is so much a matter of simple structural flaws in the markets that limit the EMH, as structural flaws in people. Your other post about limited time horizons seems more accurate. Consider:

    If one thinks back to March 1 2009, when the markets were falling daily, there was hardly a pundit who didn’t think that the market was undervalued (at DJI 7,000), but many talking heads thought the market would go to 5,000 to 5,500 before it bounced up. But if everyone agreed the market would go lower then quickly go higher, how could it go lower in the first place in a system where arbitrage is prolific (and interest rates are 2%)?

    Indeed, we had many many many people who thought the market would go higher eventually, but did not leverage themselves to do anything? The general hope was that “someone would do something” and the markets would somehow get fixed. Or fix themselves.

  7. These are all excellent points. Two issues:

    1) I’m even more skeptical about the EMH than you. The market can stay irrational longer than you can stay solvent? Then just use your own capital to buy long-dated options. Similarly, in housing, you can just rent if you really think house prices will go down–or short REITs (which would have been really really profitable). Of course, these actions probably wouldn’t be sufficient to pop the bubble, but the fact that no one even tries to do these things, for me, suggests that beliefs are really fundamentally skewed, and liquidity isn’t the problem.

    2) So we don’t buy the EMH. What does that really imply about central banking? In response to high asset prices in 1929, the Fed implemented a tight monetary policy. Friedman and Schwartz show that these policies, rather than the asset boom, were responsible for the Great Depression. More recently, the Internet boom was easily disposed of after the fact.

    Yes, rates were low after that. But the Fed has very little control over real interest rates, and it’s not at all clear how low short-term rates fed into low long-term rates, as many other factors were involved. Certainly rates went up quickly after 2004, to little effect. in order to do anything serious about housing through the central bank channel, they would have had to conduct 1929 style monetary policy. Even today, it’s not clear that would have been the right strategy–and no one would have done it then anyway.

    3) Look, sometimes prices go up, sometimes they go down. That’s a constant of markets, and it’s unrealistic to expect the Fed to maintain static prices. That’s fine. What’s not fine is when dropping asset prices destroy financial intermediation–as happened during this crisis, but not after comparable asset losses in 2000. Rather than expecting the Fed to fine-tune every price in the economy, it should play the role of regulator and systemic risk monitor to ensure that price volatility doesn’t result in damages to the wider economy. This means a) eliminating the global ‘imbalances’ that contributed to an excess of liquidity and b) more stringent regulation of financial intermediaries, and tougher leverage requirements.

  8. would it be highly improper if I translated arbitrageurs into gamblers?
    Gambler though doesn’t really satisfy me anymore
    - it sounds like family vacation in Las Vegas these days
    - I’d like to introduce the German word Zocker which describes a high risk gambler in any environment
    - if he is well dressed he maybe even gain admission to a Spielbank (Casino) (picture of the adjacent bar http://www.casino-forum.net/casino/spielbank-wiesbaden-spielsaal.jpg).
    of course one could also use hasardeur but that would again exclude the lumpen gambler

  9. arbitrageurs … can’t do their job if they are time or credit constrained … if the market stays irrational longer than they can remain solvent – they’ll collapse before they can do their job.

    Is that different than saying that a gambler who has enough money can eventually win by doubling down?

  10. Nope, it’s quite different…

    A gambler with infinite money does not change the probability of the outcome.

    An arbitrageur with infinite money can overwhelm the liquidity of the market – by buying enough of a stock, the value would go up (at least on paper).

  11. True, a gambler doesn’t influence the roll of the dice the way that an arbitrageur can influence the price on a market. But gambling, like arbitrage, involves interactivity with counter-parties. At some point, the casino or fellow gambler will decline the offer to double down. We’re all constrained by time and credit.

  12. Actually the existence of an arb-free valuation methodology (equivalent martingale measure to be precise) requires that arbitrageurs are credit constrained, since otherwise doubling down strategies–which LTCM clearly attempted, e.g., until it hit a credit constraint–can render any price possible. This is standard finance fare–c.f., Duffie, e.g.

  13. 1. How does buying long dated options or shorting REITS disprove the idea that markets can stay irrational longer than you can stay solvent? The market could simply continue being irrational past the expiration date of your options or continue a trend that forces you out of your short position? Then what? Double down? Again and Again?.

    2. Sorry, I really don’t see ANY connection between EMH and what you’re saying about central banking. In fact, it seems that the poor decisions you cite about central banking SUPPORT the idea that markets are MORE efficient than an attempt at centralized “Active Management”.

    3. What are you saying here:

    “What’s not fine is when dropping asset prices destroy financial intermediation–as happened during this crisis, but not after comparable asset losses in 2000.” Are you suggesting that the financial intemediaries should have been destroyed in 2000 also?

    Please tell us what prices you think the Fed regulates other than the price of short term money?

  14. 1. The point is that arbabitrageurs have ways to get around time and credit constraints if you really want. Even if you shorted a REIT in 2004, and you have nominal losses in 2007, if you really believe housing will collapse, you just wait until 2008. If you’re leveraged or an investor, nominal losses are a problem–so you can’t expect them to correct the market. But no one is putting a gun to your head and forcing you to pick up debt. And yet we don’t even observe these “easy” strategies being used. So I don’t think credit and time contraints are the big issue.

    2. That’s my point. Even if the EMH is false (which I believe to be the case not because of credit or time constraints), centralizing active management can fail.

    3. Equity bubbles are different from debt bubbles. When stock prices crash, people lose money, but the economy gets over it. When debt crashes, banks lose money, and credit shuts down entirely. Rather than worrying about asset prices, we should worry about the solvency of banks.

  15. donthelibertariandemocrat

    “Limits to arbitrage is a theory which assumes that restrictions placed upon funds, that would ordinarily be used by rational traders to arbitrage away pricing inefficiencies, leave prices in a non-equilibrium state for protracted periods of time.

    The efficient market hypothesis assumes that whenever mispricing of a publicly-traded stock occurs as a result of an over-reaction to news, or some similar event, an opportuntity for low-risk profit is created for rational traders. The low-risk profit opportunity exists through the tool of arbitrage, which, briefly, is buying and selling differently priced items of the same value, and pocketing the difference. If a stock falls away from its equilibrium price (let us say it becomes undervalued) due to irrational trading (noise traders), rational investors will (in this case) take a long position while going short on a proxy security, or another stock with similar characteristics.

    Rational traders usually work for professional money management firms, and invest other peoples’ money. If they engage in arbitrage in reaction to a stock mispricing, and the mispricing persists for an extended period, clients of the money management firm can (and do) formulate the opinion that the firm is incompetent. This results in withdrawal of the clients’ funds. In order to deliver funds, the manager must unwind the position at a loss. The threat of this action on behalf of clients causes professional managers to be less prone to take advantage of these opportunities. This has the tendency to exacerbate the problem of pricing inefficiency.

    Long-Term Capital Management became a victim of limits to arbitrage in 1998.”

    But then you have this problem:

    http://brontecapital.blogspot.com/2009/02/john-paulson-accuses-his-competitors-of.html

    In any case, is there any evidence of how Hedge Funds dealt with withdrawals during this crisis? Presumably, we could find out how various types of investors actually performed in a panic. Also, did investors contribute to the threat of deflation via withdrawals?

  16. Mike,

    Easterly is very wrong (depending on what he meant to say), or grossly misleading, that, “nobody can systematically beat the stock market. Which implies nobody can predict a market crash, because if you could, then you would obviously beat the market. This applies also to other asset markets like housing prices.”

    First, there’s the definition of predict. By predicting a market crash, does he mean the exact day the market will crash? The exact minute? The exact second? And with 100% perfect certainty? Then, no.

    But for EMH to be wrong, or very far from the truth, all you have to show is that you can predict with just a substantial degree of accuracy. So, if you can just show, for example, that the odds of a stock market crash are far higher in years when the P-E ratio is much higher than average (or for housing crashes the buy-rent, or price-household income ratio), or that the expected risk-adjusted long run return is much lower than average, or other “anomalies” (anomalous to the EMH) like this, then you can show that the EMH is substantially far from the truth.

    And the economics and finance literature shows this very strongly, in empirics, in theory, and in solid unbroken logic chains anchored to just very reasonable assumptions (as opposed to the ludicrous whoppers that much of the freshwater economists’ theories and models depend on).

    Here is what I think is a very important example from a 2006 letter of mine in the Economists’ Voice (Joseph Stiglitz and Brad DeLong editors), “Informed Investors Have Limited Ability to Push Prices to Efficiency” (at: http://www.bepress.com/ev/vol3/iss8/art3/):

    One reason…which I have not seen yet in the literature, at least explicitly, is that a smart rational investor is limited in how much of a mispriced stock he will purchase or sell by how undiversified his portfolio will become. For example, suppose IBM is currently selling for $100, but its efficient, or rational informed, price is $110. It must be remembered that the rational informed price is what the stock is worth to the investor when added in the appropriate proportion to his properly diversified portfolio of other assets. Such a savvy investor will purchase more IBM as it only costs $100, but as soon as he purchases more IBM, IBM becomes worth less to him per share, because it becomes increasingly risky to put so much of his money in the IBM basket. By the time this investor has purchased enough IBM that it constitutes 20 percent of his portfolio, the stock may have become so risky that it’s worth less than $100 to him for an additional share. At that point he may have only purchased enough IBM stock to push the price to $100.02, far short of its efficient market price of $110. Thus, if the rational and informed investors do not hold or control enough—a large enough proportion of the wealth invested in the market—they may not be able to come close to pushing prices to the efficient level.

    End Quote

    Easterly has strong indications of being very libertarian from what I’ve read of him, thus I am suspicious that he is misleading here intentionally. This is because any competent economist with reasonably broad expertise (which it looks like Easterly is), knows that strong or extreme libertarianism will lead to a very risky, very dangerous world, with far lower quality of life for almost everyone, far less wealth, and far lower growth in wealth, science, and medicine. In fact, because of the great inefficiencies, compared to a smart government role to deal with pure free market problems (externalities, asymmetric information, etc.), these far lower growth rates will mean that each generation will be less and less wealthy, and technologically and medically advanced. After several generations, it will be hard to find anyone who isn’t worse off due to adopting extreme libertarian policies.

    An extreme libertarian will, nonetheless, accept all of this, will accept tremendous suffering and loss of quality and length of life, in exchange for not giving up even small (or even barely noticeable) amounts of economic freedom, but the vast majority of the public will not. So, the only way to get the public to support extreme libertarian policies, is to lie about their effects, or to be tricky and not literally lie (at least by some literal interpretation you could claim), but to grossly mislead.

    The truth hurts them. It hurts the odds of getting voted in what they want. So they have a very strong incentive to grossly lie and mislead to the public. You see this all the time, sadly, from right wing economists. Greg Mankiw is the quintessential example.

    One of the common ways to mislead, sometimes intentionally, sometimes just by honest mistake, is to act as though the market is basically perfectly efficient, that is the EMH holds, because you can show that it’s not perfectly inefficient, or not extremely inefficient. Thus, such proponents will argue that the market is EMH efficient because there’s no way to find a perfect arbitrage very often, or for very long. That is, there’s no way to make money risk free 100% in the market, with no initial investment (for example, you borrow the up-front money), very often, or for very long.

    Ok, that’s true, but non-presence of massive inefficiency, does not mean presence of basically perfect efficiency. EMH claims not just that there are no risk-free, no initial investment, money pumps. It claims far more. Essentially, it’s claims lead to the Capital Asset Pricing Model (CAPM) which states that no portfolio will have a better risk-adjusted return than the market portfolio, and no stock will have a better risk adjusted return than that implied by the CAPM. But the economics and finance literature is filled with strong evidence that that’s not true. For example, investing at points of very low P/E’s and pulling out at points of very high P/E’s leads to much higher risk adjusted returns than the buy and hold market portfolio over the long run.

    You don’t have to show that you can beat the market with certainty, 100% of the time, for the market to not be perfectly efficient. If you can beat it much more than half the time, and with lower risk, then there’s a lot of inefficiency. If you can show that in some periods prices of stocks, or homes, shoot to levels that imply horrible risk-adjusted returns, and they stay there, people keep buying them, then you can show a substantial amount of inefficiency in the market.

    And, smart investors do get rich off of it. I’m sure many people did do very well over the long run by pulling out of stocks during bubbles (maybe not at the exact peak, but well in), and jumping in at troughs, when P/Es were very low. I know people who did this.

    Warren Buffet’s returns have been massively higher than anything predicted by the EMH, and it wasn’t luck (and for anyone who wants to start making marginal investor arguments here, please re-read the quote above from my Economists’ Voice letter).

    To learn more about the “anomalies” literature and other evidence against the EMH, I suggest the books:

    “Inefficient Markets”, by Harvard economist Andrei Shliefer (co-author of the article Mike discusses)

    “Stocks for the Long Run”, 4th edition, by Wharton finance professor Jeremy Siegel

    “The New Finance”, 4th edition, by Robert Haugen former Professor of Finance at the University of California, Irvine, now CEO of Haugen Custom Financial Systems (Be careful in interpreting this one. The writing is very hyperbolic. But, there is some very good research presented, and very good points made)

  17. The most important part of the much-maligned Efficient Markets Hypothesis (EMH) is that nobody can systematically beat the stock market.

    Let’s call this the “phony strawman” form of the EMH.

    EMH has never claimed “nobody” can beat the market. It is a hypothesis, that one could maybe prove that, given instant dissemination of information, all assets are fairly priced. Since nobody knows what is a fair (eventual) price, it’s kind of an empty claim.

    Also, nobody claims that all investors are equally informed; most claim that the markets are sufficiently close to efficient that opportunities for out-performance are limited.

    One uses ideas like this not because they’re obviously true, and sometimes if they’re obviously NOT in their details, but because they help frame our thinking. EMH is great for that… except that you have to know what it claims before you can use it.

  18. Hello,
    I will start with your conclusion that;
    “There’s a lot more research to be done here, but contrary to popular belief we do have an intellectual framework to know how markets can get out of whack, one that takes the EMH are brings it to a reality where we face actual constraints over scarce resources such as time and capital.”

    I recall learning about the Arbitrageurs in the mid-eighties and I was puzzled then about what all the excitement was about. Intuitively, I could not imagine how this area of analysis was going to define a framework. This is an area that certainly explains all sorts of very important anomalies – But how do anomalies make a framework? From the mid-eighties till now….this framework did not manage to predict the current financial crisis. I also read the Posheman article. Is the strategy to sum up all the anomalies to quilt together an intellectual framework? Or, did I miss something fundamental here? I guess my concern is that this area of study at once separates financial decision making from the rest of the economy without explaining the larger impact on, or basic connection to humans. Since I am very unclear about those links I am left to think that the search for anomalies ultimately depends on the same intellectual framework as EMH. Please let me know if I have missed something! Notwithstanding all my reservations and questions, I enjoyed your reading recommendations and hope there is more! Thanks!

  19. “This is because any competent economist with reasonably broad expertise (which it looks like Easterly is), knows that strong or extreme libertarianism will lead to a very risky, very dangerous world, with far lower quality of life for almost everyone, far less wealth, and far lower growth in wealth, science, and medicine. In fact, because of the great inefficiencies, compared to a smart government role to deal with pure free market problems (externalities, asymmetric information, etc.), these far lower growth rates will mean that each generation will be less and less wealthy, and technologically and medically advanced. After several generations, it will be hard to find anyone who isn’t worse off due to adopting extreme libertarian policies.”

    Richard, where is the evidence that (a) Libertarians believe, such as Greg Mankiw, actually believe in no government or (b) that real Libertarian policies would inhibit productivity or growth. I find it odd that you hold out a member of the Pigou club as the “quinessential example” of someone opposed to a government role in decreasing negative externalities.

  20. I described Mankiw as an extreme libertarian, at least he seems to lobby (and intentionally mislead) for very economically libertarian policies on his blog. I never said he was for no government at all. This would be perhaps considered by some to be the pinnacle of libertarianism, but there is a difficult tradeoff. Libertarianism is against being forced to pay for something you don’t use and don’t want to use, but then what if people opt out of paying for law enforcement and courts saying they don’t want to use them? Free rider problems get huge, and then how do you enforce all these libertarian rights to do what you want and only pay for what you want and use?

    In any case, I never said Mankiw was so extreme that he wanted no government.

    With regard to the case that extreme libertarianism would result in much less growth in science, medicine, and wealth, compared to a smart government role. The case is long, and I can’t go over it completely here; I suggest the market failure chapters of intro and intermediate college economics texts. But let’s discuss one example. Suppose an old man says I don’t want to pay for any basic scientific and medical research. I don’t care about it, and I probably won’t be alive to benefit from the vast majority of it. I don’t want to purchase it. An extreme libertarian (as “libertarian” is popularly defined) would say he shouldn’t be forced to purchase it if he doesn’t want to. Then, basic science investment becomes voluntary, and the free rider problems get huge (as well as asymmetric information problems, economies of scale, transactions costs, and others).

    Patents are impossible. The courts could spend all of the money and time in the economy and they still wouldn’t be able to decide what slivers of a product came from which of all of the basic scientific discoveries. And then, as with my comment on government in general, what if people say I don’t want to be forced to purchase or use government patent court services.

    Bottom line is making basic scientific and medical research voluntary free market, not forcing anyone to pay for it who says they don’t want to, will result in far less investment in basic scientific and medical research, and therefore a far lower growth rate in science and medicine. Because economic growth depends so much on scientific growth over the long run, this will also result in far lower economic growth.

    Now there are different levels of economic libertarianism, but the extreme forms, where you’re extremely unwilling to have someone give up even small amounts of personal economic choice even for a tremendous societal gain as with basic research, the more you have of this extreme form, the more you constrain yourself from optimizing growth in science, medicine, wealth, and total societal utility.

  21. While I appreciate the invitation to open a basic econ book and look up market failure, the example of an old man not paying for medical research he has no use for is entirely tangental to the argument that governments must step in to fix market inefficiencies. It is possible that other old men that fear death, and their families, would pay for basic research done by for-profit firms based on the number of old men that wish to avoid negative outcomes. Milton Friedman, Gordon Tullock and George Stigler have all published research demonstrating that market inefficiency is often outweighed due government inefficiency to buraaucracy, rent-seeking and special interests.

    This is not to say that there are not sophisticated arguments against certain aspects of libertarian thought, but I can think of none that relate to EMH. However, if the intention is to impugn Easterly’s work by associating him with Libertarian thought then it is probably best to assume readers of an economics blog have in fact read at least a basic economics textbook.

    While this was obviously only a comment on a blog post and not a fully cited and journal submission it would be nice to see clear support for claims as incendiary as “The truth hurts them. It hurts the odds of getting voted in what they want” rather than hyperbole and straw-men that “grossly lie.” After all, what if there were children reading? They might have taken this seriously.