Are markets efficient? The extreme case of corporatebankruptcy: a literature review

In 1970, Fama presented the foundations of what was to become the central proposition in finance: the Efficient Market Hypothesis (EMH). Under the EMH’s framework, a market is efficient if prices always reflect all available information. Behavioural finance is an alternative perspective to understand financial markets, which incorporates the implications of psychological decision processes. This new framework is based on a well-developed theoretical body, which provides a better explanation to certain patterns of market behaviour that cannot be understood within the traditional approach. The emergence of behavioural finance created a fundamental dilemma in the finance literature: which of the two competing theories best describes the actual behaviour of financial markets? This paper reviews existing knowledge on how markets behave when companies announce bankruptcy. This acute and economically significant bad news event constitutes an attractive scenario to explore the irrational pricing patterns that are motivated by market participants’ biases and psychological defences in dealing with extreme bad news