I’ve been catching up on some reading and I found this article in The Economist which is a few weeks old. In general I seem to criticise those who rubbish the Efficient Markets Hypothesis too much, but then there is the US Supreme court who it seems may take it too seriously.
JAMIE OLIS knows better than most people that the ideas conjured up by economists in their ivory towers can have a big effect on the real world. The tax accountant, found guilty of committing fraud while working for Dynegy, an energy-trading firm, has been doing time since March 2004, in large part thanks to a controversial economic theory, the efficient markets hypothesis.
Not just a little bit of time mind you, but 24 years, at least until a court threw out the sentence.
…In 1988, in Basic Inc v Levinson, the court endorsed a theory known as “fraud on the market”, which relies on the efficient markets hypothesis. Because market prices reflect all available information, argued the [Supreme] court, misleading statements by a company will affect its share price. Investors rely on the integrity of the price as a guide to fundamental value. Thus, misleading statements defraud purchasers of the firm’s shares even if they do not rely directly on those statements, or are not even aware of them.
Which is fine except for the fact that we know that prices move around regardless of new information, at least not the sort of information that comes from public announcements. Similarly news may take some time to be absorbed by the market which may over-react, and it is well known that volatility clusters. Don’t announce a fraud when the market is already volatile, the moves are likely to be bigger. Its a very tough call to equate a market move after an announcement entirely to that announcement, or even know when do you consider the information fully incorporated.
Of course that hasn’t stopped the lawyers and Judges from using it.
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