The Global Financial Crisis and the Efficient Market Hypothesis: What Have We Learned?

Abstract:     
The sharp economic downturn and turmoil in the financial markets, commonly referred to as the “global financial crisis,” has spawned an impressive outpouring of blame. The efficient market hypothesis - the idea that competitive financial markets ruthlessly exploit all available information when setting security prices - has been singled out for particular attention. Like all good theories, market efficiency has major limitations, even though it continues to be the source of important and enduring insights. Despite the theory’s undoubted limitations, the claim that it is responsible for the current worldwide crisis seems wildly exaggerated. This essay discusses many of those claims. These include claims that belief in the notion of market efficiency was responsible for an asset bubble, for investment practitioners miscalculating risks, and for regulators worldwide falling asleep at the switch. Other claims are that the collapse of Lehman Bros. and other large financial institutions implies market inefficiency, and that an efficient market would have predicted the crash. These claims are without merit. Despite the evidence of widespread anomalies and the advent of behavioral finance, we continue to follow practices that assume efficient pricing.

Number of Pages in PDF File: 27

Keywords: market efficiency, asset bubbles, financial crisis

JEL Classification: G14, G18, M40

Accepted Paper Series