Are Markets Efficient?

Are Markets Efficient?

Are Markets Efficient?

Are Markets Efficient?

Investors who believe that markets are efficient and who themselvesare risk averse will seek to hold efficient portfolios. Since it is a trivially simple task to create efficient portfolios, betas can be for them effectivetools. For other investors, betas and most of the other apparatus ofthe modern science of investment are of less use.

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The second explanation is based on other disturbing departuresin the real world from Sharpe's model of the determination of riskpremiums. As has been stated, according to Sharpe, the expected riskpremium on any asset is the product of the risk premium on the marketand the asset's beta coefficient. Returns in the real world are not determined in quite that way.

The main finding of Black, Jensen, and Scholes is that the riskpremium on an asset is not strictly proportional to its beta. For theperiods of their study, the returns on stocks with high betas were lowerthan would be expected on the basis of Sharpe's one-factor model;the returns on low beta stocks were higher.

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A practical implication of the two-factor model is that during theperiod of the study, 1926-66, superior returns for any level of riskcould have been obtained, by levering low-risk (beta) stocks to thedesired level of risk.

Those who questioned the usefulness of betas, either because oftheir instability or because they were not related to returns in exactlythe way implied by Sharpe's model, should think again. Efficient port folios have stable betas and the relationship between betas and returns,though more complex than implied by Sharpe, is still rational andobservable and useful in managing money.

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