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How Did Financial-Crisis-Based Criticisms of Market Efficiency Get It So Wrong?

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  • Ariane Szafarz

Abstract

In the aftermath of the financial crisis, market efficiency is being heavily criticized. However, the volatility-based criticisms rely on false grounds as efficiency and speculative bubbles are compatible. Indeed, the efficient market model is about rationality and information, not about stability. This model admits multiple solutions, as do most rational expectations models. One solution is the so-called fundamental one while the others are referred to as rational bubbles. Still, many practitioners, and even some financial academics, keep denying that speculative bubbles are compatible with efficient markets. This paper argues that not only would the recognition of efficient market multiplicity thwart irrationality-based theories, but it would also allow for further empirical developments taking full advantage of the power of diversity. The multiple price dynamics compatible with market efficiency represent a valuable asset largely underestimated by the profession.

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Paper provided by ULB -- Universite Libre de Bruxelles in its series Working Papers CEB with number 09-048.RS.

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Length: 18 p.
Date of creation: 2009
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Handle: RePEc:sol:wpaper:09-048

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Keywords: Efficient Markets; Multiple Solutions; Rational Expectations; Speculative Bubbles; Volatility.;

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Cited by:
  1. Costa Cabral, Nazare, 2010. "Breve guia temático e bibliográfico sobre o estudo da actual crise financeira e económica
    [Short thematic guide to the study of current financial and economic crisis]
    ," MPRA Paper 20743, University Library of Munich, Germany.

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