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Cuba Shows That The Efficient Markets Hypothesis Is Wrong

This article is more than 9 years old.

A standard part of the sort of free market, classically liberal, economics that I subscribe to is the efficient markets hypothesis. No, this doesn't mean that markets are efficient, nor that markets are the efficient way of handling everything. Rather, that markets are efficient at processing the information about what prices should be in markets. And while I do still subscribe to the point it can be difficult at times, as this story about Cuba shows. No, not Cuba the place so much, as a fund with the stock ticker CUBA and the reaction to Obama's recent announcement of the limited ligting on the ban on trade with or visiting Cuba.

The point being that we really shouldn't end up with a stock whose ticker is "CUBA" soaring just because of a minor change in the ability to trade with Cuba the place. But that is what has happened:

Investors in a tiny American fund have received an extraordinary windfall, apparently as a result of the four-letter symbol used to identify the fund on the US stock market.

The fund, called Herzfeld Caribbean Basin, has stakes in a number of companies that could benefit from last week's decision by Barack Obama to restore relations with Cuba. But the bulk of the rise in the fund's share price seems to be due to investors being drawn to its four-letter code or "ticker" symbol: CUBA.

The fund, listed on the Nasdaq stock market and similar to an investment trust in Britain, was trading at about $7 on Tuesday last week, before Mr Obama's announcement. It quickly rose to about $10 the following day and has risen strongly since. Today the share price stood at about $14, so the fund has roughly doubled in value.

The underlying value of the investments in the fund hasn't changed by anything like that in the time since the announcement. So we really do have to conclude that people just bought it on the ticker name. At which point we'd probably conclude that markets aren't being efficient in our specific sense on this particular occasion.

However, there's two comebacks to this. The first being that we're not, in the milder versions of that efficient markets hypothesis, actually saying that all prices are right all the time. We're really saying that they tend to being correct and tend to do so faster than any other method that we know of. It's rather like the definitions of a pure free market. Sure, we know that there isn't and has never been, according to the strictest definitions of one, a pure free market anywhere or anywhen. However, we can also observe that we don't have to get very far away from monopoly or oligopoly to find everyone acting pretty much like they would in that impossible free market. Five or six players in a marketplace is usually enough for us to see what we think of as free market behaviour. So it is with the efficient markets hypothesis. Maybe it's not entirely and totally true: but enough of the world works in that manner to make it still a useful assumption.

The other comeback is rather more trite, in that the rise could be entirely rational:

This is not the first time that a share's ticker symbol, rather than the fundamentals of the business, has influenced trading. Last year some investors mistakenly bought shares in an obscure company called Tweeter Home Entertainment, ticker symbol TWTRQ, thinking that they were investing in Twitter , which had just announced its intention to list its shares under the symbol TWTR.

Well, if you think that people are foolish enough to do this then yes, purchasing the stock ahead of the rubes is entirely rational. And it's actually an example of the markets being highly efficient: processing the information about peoples' misconceptions about the difference between Cuba and CUBA.

Update: A reader, Chris (if you want to be further identified, let me know) tips me that Mr. Herzfeld, the guy running the CUBA fun, has sold some stock.

Code V Amount (A) or (D) Price
Common Stock 12/19/2014 S 100,000 D $11.5174 424,722 D
Common Stock 12/22/2014 S 100,000 D $13.0865 324,722 D

D stands for "disposed of", ie these are sales.

As a result Mr. Herzfeld strikes me as being a very sensible chap. With these sorts of funds when the stock is at a premium to net asset value then sell them. when at a discount, then buy. At least someone is playing the market efficiently here: and that's how the efficient markets hypothesis works, to, as a result of the actions of people in the market.

 

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