Research Handbooks in Law and Economics series
Edited by Claire A. Hill and Brett H. McDonnell
Chapter 24: Market Efficiency After the Fall: Where Do We Stand Following the Financial Crisis?
Ronald J. Gilson* and Reinier Kraakman The financial crisis created a lot of losers. Investors, from individuals who thought that highly rated asset-backed securities were liquid, to German Landesbanks that purchased mortgagebacked securities that they did not and perhaps could not understand, lost very large amounts of money. Major financial institutions across the world were decimated, resulting in massive provision of government assistance and sometimes in full nationalization or failure. Further up the food chain, some large developed countries now face apparently unsustainable budget deficits, and some smaller European nations – examples to date include Greece, Iceland, Ireland and Portugal – have required large international aid packages to avoid defaults on sovereign debt. The resulting pressure to drastically reduce government spending threatens political stability across Europe and, should the United States seriously address budget deficits, perhaps there as well. Against this backdrop, one might think it of small consequence that the financial crisis is also said to have dealt major setbacks to academic theories, most particularly the Efficient Capital Market Hypothesis (ECMH) (Fox 2010). After all, academic proponents of positions whose value the financial crisis is said to have degraded suffer no material losses other than to their egos. Indeed, academic theories by their nature operate to solicit their contradiction, a point famously stressed by Thomas Kuhn (1962) almost 50 years ago. Nevertheless, two things make this iteration of theory and response to the ECMH different in the post-financial crisis context. The first is that the ECMH has moved beyond the academic...
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