Option Returns - Empirical Results

Previously, I looked at what we'd expect call and put options would be if we assumed that stock returns follow a normal distribution (see the Expected Return of a Call Option and Put Option).

My findings indicated that the underlying assumptions of the Black-Scholes pricing model are inconsistent with the mean-variance view of risk. This was not an empirical result, mind you. Empirically, I've yet to find a single set of financial data that was normally distributed. It was a theoretical result; the theory is inconsistent with a mean-variance view of risk and return.

Today I'll be looking at some odd empirical results. I wanted to see what actual returns actually looked like. As it turns out, they're even worse than what the theory predicts.

The Efficient Markets Hypothesis is Meaningless

I'm going to begin a critique of the Efficient Markets Hypothesis (EMH). This is not the first nor will it be the last that have been presented. Most of these critiques accept the basic paradigm an attempt to empirically prove that one can "beat the market".

For the practitioner, this can be quite appealing as it allows one to find some strategy that would allow one to earn "excess returns".

My approach, which I've been toying with in my mind for the last year or so, is going to be a bit different. My contention is that the entire paradigm is questionable and perhaps "meaningless"¹. At the very least, proponents of EMH have a a lot more work to do as there is a lot of ideological baggage and not much in the way of a legitimate scientific hypothesis.

Follow-up On Investment Poll

In an earlier blog I presented a poll with three alternatives (if you haven't taken the poll, see here). There's some observations at the above blog as well as at Fool and OSV.