The efficient market and market bubbles explained by a heterogeneous least-squares learning approach to fundamental analysis

A financial model is presented which resolves the ambiguity in the efficient markets concept. Fundamental investors do not build self-contained models of return but rather isolate particular factors out of observed return in order to understand it. Price is not the weighted average of individual views but the product of interlocking expectations, and the continual revision of expectations causes price to gravitate to the efficient point. This behaviour can be understood in terms of a hidden substrate in which price is an information storing vector, analogous to a gene in biology, and heterogeneous least squares learning is a genetic operator. The movement of price to the efficient point is emergent behaviour which cannot be determined from the initial state of the investors.