From Random Walks to Chaotic Crashes: The Linear Genealogy of the Efficient Capital Market Hypothesis

Abstract:     
This Article argues that chaos theory, noise theory and behavioral finance mandate opening a new chapter in a voluminous corporate and securities law debate revolving around the efficient capital market hypothesis (ECMH), which for decades has been the context for debating corporate and securities law and policy. The debate has been defined by interpretations of the semi-strong form of the ECMH - the claim that security prices fully reflect all publicly available information. As such, the debate has assumed as true and built upon the weak form of the ECMH - the claim that security prices fully reflect all information consisting of past security prices. This Article analyzes the historical development of the ECMH, showing that the weak and semi-strong forms of the ECMH are based on linear methodology and thought that have been rendered obsolete by chaos models applying nonlinear techniques. This obsolescence renders the ECMH false in all its forms, rendering it moot for purposes of policy formulation on topics ranging from such basic corporate and securities law doctrines as mandatory disclosure rules and mandatory fiduciary obligation, which neither the ECMH nor noise theory can do to the capital market circuit breakers and relational investing.

Keywords: efficient markets, CAPM, modern porfolio theory, modern finance theory, chaos theory, nonlinear dynamics, intellectual history, capital markets, noise trading, mandatory disclosure, fiduciary duty

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