Saturday, January 23, 2010

Rajiv Sethi on Market Bubbles and Timing the Exit

In a post ostensibly about the efficient market hypothesis, Rajiv Sethi takes on a key argument (which looks eerily like the $20-bill argument) for EMH:

There are really two separate questions here: can bubbles be reliably identified in real time, while they are in the process of inflating, and if so, does this present opportunities for making abnormally high risk-adjusted returns? It is possible to answer the first question in the affirmative but not the second, for the simple reason that the eventual size of the bubble and the timing of the crash are unpredictable. Selling short too soon can result in huge losses if one is unable to continue meeting margin calls as the bubble expands. Trying to ride the bubble for a while can be disastrous if one doesn't get out of the market soon enough. And avoiding the market altogether can also be risky, if one's returns as a fund manager are compared with those of one's peers.

Each of these risks may be illustrated with some vivid examples from the bubble in technology stocks that eventually burst in April 2000. [...]


  1. Sachin Shanbhag said...

    Perhaps, the following essay/speech by Warren Buffett taking the opposite stand may be of interest.