The Efficient Market Hypothesis stands on one word: information. Markets are efficient, the argument runs, because prices reflect all of it. The case has long been recognised as weak — but as Martin Sewell put it, criticism of a flawed hypothesis achieves little until a better hypothesis replaces it. This paper takes the replacement seriously.
Its starting point is Kenneth Boulding’s 1966 observation about the peculiar economics of knowledge, and the literature that followed Ball and Brown (1968) on information content, relevance and irrelevance. The Reversion Diversion Hypothesis reframes the whole line: information is not a constant input but a quantity that transforms from relevance to irrelevance — still technically “available,” no longer informative.
The mechanics
| EMH leans on | RDH replaces it with |
|---|---|
| Information as a constant input | Information that decays — relevance transforming into irrelevance |
| Prices reflect all available information | Prices reflect currently relevant information |
| Efficiency as a state markets are in | Efficiency as a moving target — a process, never finished |
Relevance has a half-life
Information does not arrive priced; it decays into the price — and different information decays at different speeds. A headline is absorbed in days; an earnings cycle over quarters; a structural fact can take years to be fully believed. The efficient-market shorthand treats all of it as instant. RDH gives each item a half-life instead.
The portfolio consequence: alpha lives inside the decay window. A system that measures how much relevance an item of information still carries can size positions to the remaining life of the information — rather than to conviction, recency, or noise that has already reached the floor.
What it means for portfolios
The portfolio consequence is the licence for everything else in this series: if information decays, then a benchmark can be built to weight what still carries signal. Cap-weighting freezes yesterday’s information into today’s allocations; an information-weighted construction re-prices relevance continuously. Understanding value, the paper insists, begins with understanding information — and information, properly understood, has a half-life.
- EMH’s weakness is its treatment of information as a constant; RDH models it as a decaying quantity.
- Efficiency becomes a process — a moving target — rather than a state markets occupy.
- If information decays, an information-weighted benchmark is possible: weight what still carries signal.
Pal, M. (2015). Reversion Diversion Hypothesis. SSRN 2690677.
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