MacKenzie D. An engine, not a camera.. How financial ... - TiERA

104 Chapter 4The testimony of arbitrageurs (in, for example, my interview with DavidShaw) is that in addition to the anomalies discussed in the literature of financialeconomics that are exploitable market inefficiencies that are not publiclyknown. Naturally, arbitrageurs are reluctant to say exactly what they are:others’ exploitation of them would very likely reduce or eliminate them. Evenin 1965 it was clear to James Lorie, founder of the Center for Research inSecurity Prices, that such anomalies might exist: “. . . there is a haunting fearthat those with the best arguments [against the random-walk hypothesis] aresilently sunning and swimming at St. Tropez” (Lorie 1965, p. 18).Furthermore, one practical application of efficient-market theory, indexfunds, seems to have created an anomaly, rather than identifying a pre-existinganomaly. The composition of the S&P 500 and similar indices is not fixed.Periodically, firms are added to and deleted from them, because of mergersand bankruptcies and to reflect changes in the market values of corporationsand in the overall makeup of the stock market. From an efficient-market viewpoint,the inclusion of a corporation in an index or its deletion from it shouldnot affect the price of its stock: it seems to convey no information about thecorporation that was not previously known. 18However, Andrei Shleifer, who was to become a leader of behavioralfinance, found that from 1976 to 1983 the inclusion of a stock in the S&P 500index was associated with an average rise in its price on the day of theannouncement of its inclusion of just under 3 percent (Shleifer 1986, p. 582). 19The effect survived its identification: between 1976 and 1996, the averageincrease was 3.5 percent. To take an extreme case, the price of stock of AOL(America Online) went up by 18 percent when its inclusion in the S&P 500was announced (Shleifer 2000, p. 22).At one level, the cause of an increase in price following a stock’s inclusionin the S&P 500 or similar indices seems straightforward: index funds, whichas noted in chapter 3 have become an extremely large category of investor, donot hold the stock before its inclusion, and when it is included they have tobuy it. Again, though, such an explanation is unsatisfactory from the viewpointof efficient-market theory. It runs directly against a central tenet of financetheory, which goes back to Modigliani, Miller, Markowitz, and Sharpe butwhich was expressed perhaps most clearly by Myron Scholes on the first pageof his Ph.D. thesis: “The shares a firm sells are not unique works of art, butabstract rights to an uncertain income stream for which close counterparts existeither directly or indirectly via combinations of assets of various kinds.”(Scholes 1970, p. 1)If a purchase or sale of stock conveys no information—if it is not, forinstance, the result of a corporate insider unloading stock before bad news