The Mechanisms of Market Efficiency

Abstract

Of all recent developments in financial economics, the efficient capital market hypothesis ("ECMH") has achieved the widest acceptance by the legal culture. It now commonly informs the academic literature on a variety of topics; it is addressed by major law school casebooks and textbooks on business law; it structures debate over the future of securities regulation both within and without the Securities and Exchange Commission; it has served as the intellectual premise for a major revision of the disclosure system administered by the Commission; and it has even begun to influence judicial decisions and the actual practice of law. In short, the ECMH is now the context in which serious discussion of the regulation of financial markets takes place. Yet the legal culture's remarkably rapid and broad acceptance of an economic concept that did not exist twenty years ago is not matched by an equivalent degree of understanding. The disparate ways in which the legal culture employs the ECMH share a single, and to us critical, commonality. They rest on legal and policy implications derived from the ECMH (particularly in its semi-strong form) without serious attention to how these implications depend on a more preliminary question: What makes the market efficient when it appears to be so?

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