Market efficiency and the Global Financial Crisis

The Global Financial Crisis (GFC) has led many journalists, market participants and politicians to reject the efficient markets hypothesis (EMH). For example, in a much discussed essay in The Monthly, former Australian Prime Minister Kevin Rudd blamed the GFC on ‘belief in the superiority of unregulated financial markets’, a belief he claimed ‘ultimately rest[ed] on’ the EMH (Rudd 2009). He asserted that this belief had ‘failed’ and called for much greater financial market regulation. Our purpose in this student note is to present an analysis of the evidence with respect to market efficiency and to discuss what additional evidence, if any, the GFC provides. Such a presentation requires making a distinction between micro-efficiency and macro-efficiency. At the micro level, market efficiency is the extent to which the prices of financial securities reflect information relative to other securities within the same asset class; for example, whether BHP Billiton shares are fairly priced when compared with RIO shares or whether one firm’s collateralised debt obligations are fairly priced when compared with those of another firm. At the macro level, the issue is whether the market as a whole reflects all available information — whether, for example, the share market is fairly priced compared with a less risky asset class such as government debt. Careful analysis of this evidence demonstrates the need to avoid overly simplistic assertions based upon it and to carefully assess whether any efficiencies are such that available market correction instruments are likely to achieve more good than harm