The Efficient Markets Hypothesis is an oft-debated theory in financial economics, and important to consider for people who want to make money by “beating the market.” In particular, it implies that it is difficult for investors to outperform the market in the long-term. Investopedia describes EMH as saying that “at any given time, prices fully reflect all available information on a particular stock and/or market. Thus, according to the EMH, no investor has an advantage in predicting a return on a stock price because no one has access to information not already available to everyone else.” (note: this also assumes regulation that makes relevant information public, and market liquidity).
- On Friday March 11, 2011 an earthquake measuring 9.0 on the Richter scale struck near the coast of Japan’s main island of Honshu. This earthquake occurred at 2:46pm local time in Tokyo.
- The Tokyo Stock Exchange closes at 3pm local time.
- Japan has a $1 billion earthquake early-warning system comprised of over 1000 GPS-sensors, that gave people “enough time for people to switch off their gas lines and get beneath a table or a door frame. And was especially helpful to those in Tokyo who were 230 miles from the epicenter and therefore may have had an additional 80 seconds to prepare.”
- On Monday following the earthquake and tsunami, “[Japanese construction firms] Hazama Corp. and Kumagai Gumi, for example, jumped more than 40 percent, and Kajima Corp., one of the biggest in the sector, rose 22.2 percent. Many others saw gains of well over 10 percent.” It was also very possible to make money from shorting stock in companies like Toyota and Sony, but slightly riskier, so for now let’s only consider the companies that saw huge gains.
- Trading for Hazama Corp. closed at 73.00 on Friday, March 2011.
What’s the missed opportunity here? Apparently no intrepid/cynical trader had a computer program that would (1) Link to the earthquake early warning system and know instantly when a 8.5+ earthquake was on its way, (2) use the two minutes of notice to vacuum up construction company stocks. Notice that the design of the earthquake detection and early warning system incorporates high confidence that an earthquake is real and dangerous. And the risk appears very low as long as you don’t overpay for these stocks, since they seem to trade at very stable prices. The profit-potential was large: one-day returns in the double-digits.
Perhaps no one did this because of the morally-questionable nature of profiting from human suffering (something to cover in a future post). But given that speculators routinely show no qualms in profiting from failure or disaster in other cases, and in some ways may even induce it (e.g. short-selling), I have to suspect that this is an example of market inefficiency.