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The Paradox of 'Fraud-on-the-Market Theory': Who Relies on the Efficiency of Market Prices?

52 Pages Posted: 28 May 2008 Last revised: 15 Aug 2009

Grigori Erenburg

University of Western Ontario - King's University College

Janet Kiholm Smith

Claremont McKenna College - Robert Day School of Economics and Finance

Richard L. Smith

University of California, Riverside - Anderson Graduate School of Management

Date Written: April 9, 2009

Abstract

Our evidence points to an inconsistency between the efficient markets hypothesis and the way U.S. courts have applied the hypothesis in cases involving allegations of fraud on the market. Based on a sample of securities class action cases, we find that (1) some cases certified for class action status do not satisfy the conditions for even weak-form efficiency; (2) numerous opportunities exist for cost-effective investors (those who can trade quickly and at low cost) to profit by using simple momentum-based strategies; (3)including such investors as class members effectively subsidizes their strategies and overstates damages from reliance on market efficiency; (4) when such investors can profit by rejecting market efficiency, standard measures of damage overstate the fraud-related damage of other investors; (5) because of endogeneity, the factors that commonly are relied on by the courts for determining market efficiency bear little or no relation to weak-form efficiency.

Keywords: Fraud on the market, securities litigation, market efficiency

JEL Classification: G14, G18, K22

Suggested Citation

Erenburg, Grigori and Smith, Janet Kiholm and Smith, Richard L., The Paradox of 'Fraud-on-the-Market Theory': Who Relies on the Efficiency of Market Prices? (April 9, 2009). Robert Day School of Economics and Finance Research Paper No. 2008-2. Available at SSRN: https://ssrn.com/abstract=1138018 or http://dx.doi.org/10.2139/ssrn.1138018

Grigori Erenburg

University of Western Ontario - King's University College ( email )

266 Epworth Avenue
London, Ontario N6A 2M3
Canada

Janet Kiholm Smith (Contact Author)

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

500 E. Ninth St.
Claremont, CA 91711-6420
United States
909-607-3276 (Phone)

Richard L. Smith

University of California, Riverside - Anderson Graduate School of Management ( email )

Riverside, CA 92521
United States
951-827-3554 (Phone)

HOME PAGE: http://www.agsm.ucr.edu/

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