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

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  • Ariane Szafarz

Abstract

Criticizing the Efficient Market Hypothesis (EMH) on the basis of highly volatile asset prices is conceptually wrong as efficiency is about rationality and information, not about stability. Speculative bubbles are compatible with rational valuation, and hence with market efficiency. As rational expectations are auto-referential, multiple solutions are a natural outcome. This paper attributes the prevalent confusion between bubbles and irrationality to the bad reputation of multiple-solution models often considered as underspecified. It argues that multiple solutions rather represent an opportunity to economists by bringing theoretically sound degrees of freedom to empirical implementation. Moreover, the recognition of multiple price dynamics compatible with market efficiency thwarts irrationality-based theories and, as such, is a valuable asset largely underestimated by the profession.

Suggested Citation

  • Ariane Szafarz, 2010. "How Did Financial-Crisis-Based Criticisms of Market Efficiency Get It So Wrong?," DULBEA Working Papers 10-01.RS., ULB -- Universite Libre de Bruxelles.
    • Handle: RePEc:dul:wpaper:10-01rs
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    1. Campos Dias de Sousa, Ricardo Emanuel & Howden, David, 2015. "The Efficient Market Conjecture," MPRA Paper 79792, University Library of Munich, Germany.
    2. 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.
    3. Xavier De Scheemaekere & Kim Oosterlinck & Ariane Szafarz, 2014. "Issues in Identifying Economic Crises: Insights from History," Working Papers CEB 14-014, ULB -- Universite Libre de Bruxelles.
    4. Philip Mirowski, 2011. "The Spontaneous Methodology of Orthodoxy, and Other Economists’ Afflictions in the Great Recession," Chapters, in: John B. Davis & D. Wade Hands (ed.), The Elgar Companion to Recent Economic Methodology, chapter 20, Edward Elgar Publishing.

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    More about this item

    Keywords

    Efficient Markets; Multiple Solutions; Rational Expectations; Speculative Bubbles; Volatility.;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • B41 - Schools of Economic Thought and Methodology - - Economic Methodology - - - Economic Methodology

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