Earthquakes and Efficient Markets Theory

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┬ábecause 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).

Today I wanted to contribute evidence against the Efficient Markets Hypothesis, and give a somewhat cynical example of a specific missed opportunity to profit immensely from a natural disaster.

  • 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┬ábeneath 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.

restaurant review: A taste of North Korea at Pyongyang Soondae (Northern Virginia)

Pyongyang Soondae

6499 Little River Turnpike, Alexandria, VA

A while back I read my friend Tao’s Facebook note detailing an exciting culinary adventure. While visiting Dubai, he found a restaurant called Okyru-Gwan that serves North Korean food. It’s operated by the state of North Korea, and the other branches are in Beijing and Cambodia–expansion to the United States seems unlikely. Despite the small size of the peninsula they share, North Korean food is apparently different from food in the South, and as a foodie I envied Tao’s opportunity to sample such an exotic product, and was dismayed that the only apparent place to find it was at an institution that serves as a source of foreign currency and money laundering for Kim Jong-Il.

Then a few weeks ago I read a great article in everyone’s favorite local D.C. publication, the Washington City Paper. They reviewed a restaurant owned and operated by North Koreans. The owner is a North Korean woman who formerly worked as a spy before defecting (her story is quite thrilling, so I encourage you to read the article), and now lives in Northern Virginia. Not only does her restaurant serve authentic North Korean food, it employs many North Korean refugees. I knew I had to visit Pyongyang Soondae. Not only would I get to eat a new food, and in so doing travel to a new and completely restricted place, but I would thumb my nose at Kim at the same time by supporting the economic activities of North Korean refugees.

Let me diverge from the restaurant review for a moment and discuss an anxiety I feel when eating food from cultures that typically do not dine as sumptuously as Americans: Is it wrong to enjoy large, protein-rich meals prepared in the style of Ethiopia, Laos, or North Korea when actual people in those countries rarely eat protein abundantly, and millions are starving in North Korea? Perhaps conveniently, I’ve concluded ‘no’. Few would say that tourism to Laos or Ethiopia and observation of their history and culture is wrong, even if most residents of those countries couldn’t share that experience, perhaps because foreign tourism directly benefits a local economy. At a place like Pyongyong Soondae, where our own waitress had escaped North Korea, eating there, in some small way, supports the livelihoods of those who represent by their very survival a courageous opposition to tyranny. Second, there’s the common reaction of “you had North Korean/Ethiopian food? What is that, dirt and worms?” Such trite jabs are ultimately mistaken–while the current populations of those countries may be impoverished, their culture and history are still rich, and their pride in their civilization is not diminished. I’m a big fan of No Reservations, and you can see on the show how his hosts in poorer countries pull out all the stops and prepare veritable feasts for Bourdain and his crew. Every country has some version of the Greek xenia–the guest-host relationship–and all over the world guests are feted precisely to impress them with the special offerings of a family, a heritage, or a country. On a more abstract level, I like to think of ideas as engaged in an evolutionary game of survival. We want our values to be shared, because the more adherents the more powerful (and perhaps the more validated) the idea, and because with greater numbers our ideas can survive the attrition of time. So in that way, I don’t think it’s callous to enjoy the cuisines of poor countries, because we pay tribute to them in broadening our horizons, and with our appreciation we strengthen the fitness of their culture. Anyway.

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