Chapter 11: If Markets are Efficient Why Has There Been so Much Volatility in Financial Markets?
11. If markets are eﬃcient why has there been so much volatility in ﬁnancial markets? In the decades of the 1980s and 1990s the world witnessed increasing volatility in many ﬁnancial markets around the world. Why is there so much volatility? Are ﬁnancial markets inherently destabilizing and fragile or is today’s ﬁnancial fragility the result of market ‘liberalization’ policy decisions taken since the 1970s? We are again being haunted by Minsky’s frightening ﬁnancial fragility question ‘Can it happen again?’1 where ‘it’ is a replay of the Great Depression. 11.1 EFFICIENCY VERSUS LIQUIDITY Peter L. Bernstein is the author of the best-selling book Against the Gods,2 a treatise on risk management, probability theory and ﬁnancial markets. Bernstein noted that since the Second World War ‘the number of stock markets around the world has grown from 50 to just over 125 – even the Chinese, nominally still socialists have seen ﬁt to establish stock markets on their territory’.3 Accordingly, one might ask, if ﬁnancial markets are, as Minsky suggests, so fragile and destabilizing, why are so many emerging economies using them? How one responds to these queries depends on the underlying economic theory that one explicitly, or implicitly, utilizes to explain the role of ﬁnancial markets in an entrepreneurial economy. The eﬃcient market theory assumes that ﬁnancial markets can reliably forecast the future and therefore market values accurately reﬂect the present value of the ‘known’ future stream of money receipts that will accrue to the asset holder. E...
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