Thursday, April 23, 2009

The Irony of Arbitrage, Efficient Markets and Equilibrium

Inevitable yet paradoxically unreachable. Like the Greek myth of Tantalus, eternal temptation without satisfaction. Proponents of the efficient market hypothesis (EMH) state that it is impossible to exploit the markets. This reflects an interesting conundrum for would be arbitrageurs who look for inefficiencies to create abnormal profits.

One the one hand, they need to vigourously search for arbitrage opportunities to exploit. However, the harder they look collectively, the less there are. This leads to a sort of equilibrium, and a self fulfilling prophecy and would probably make an interesting case for game theory.

However, as a model for human behaviour, I find it incredibly interesting / ironic that there are a number of situations for which this type of model applies.

As I have previously written in a variety of posts, I feel as if any intrinsically unstable situation will eventually result in a recovery to it's equilibrium, however, it requires triggers and intervention in order to manifest. It requires a sort of perverse vigilance to the contrary.

Perverse in the sense that in order to maintain belief that equilibrium is inevitable simultaneiously requires a belief that the current situation is never in equilibrium. It's very paradoxical in the sense that the intended goal is assumed to be inevitable yet unreachable.

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