36 Pages Posted: 6 Oct 2003
"Market indeterminacy" is the inability to determine whether asset prices are efficient or inefficient, that is, whether or not asset prices fully and immediately reflect available information, such that no investor can earn abnormal expected returns by trading on available information at current prices. Market indeterminacy pervades asset markets because we lack reasonably precise models of "correct" prices, sometimes called models of "fundamental value," against which we can compare observed asset prices to detect efficiency and inefficiency. Arbitrageurs face market indeterminacy as well, so there is little reason to think that professional arbitrage will inevitably drive prices to fundamental values. Market indeterminacy casts doubt on the usefulness of the market efficiency concept in law and policy. For example, contrary to current practice there is insufficient scientific basis to characterize some markets as efficient and others as inefficient for purposes of the fraud-on-the-market theory of securities law. Market indeterminacy also undermines the reliability of event studies as a useful tool to measure the change in "fundamental value" at the time of an event, thus rendering event studies undependable in some litigation and policy applications. Finally, market indeterminacy makes it hard to regulate financial markets.
JEL Classification: G14
Suggested Citation: Suggested Citation