Economics and Economic Systems by Britannica Educational Publishing

Author:Britannica Educational Publishing
Language: eng
Format: epub
Publisher: Britannica Educational Publishing
Published: 2013-09-15T00:00:00+00:00

FINANCIAL ECONOMICS

Although news about the stock market frequently dominates financial journalism, only since the late 20th century was the stock market recognized as an institution suitable for economic analysis. This recognition turned on a changed understanding of the “efficient market hypothesis,” which held that securities prices in an efficient stock market were inherently unpredictable—that is, an investment in the stock market was, for all but insider traders, equivalent to gambling in a casino. (An efficient stock market was one in which all information relevant to the discounted present value of stocks was freely available to all participants in the market and hence was immediately incorporated into their buying and selling plans; stock market prices were unpredictable because every fact that made them predictable had already been acted on.) In the famous economists’ joke, there is no point in picking up a $10 bill lying on the sidewalk, because if it were real, someone else would already have picked it up.

The growth of financial markets, the deregulation of international capital markets, and the unprecedented availability of financial data gradually undermined the efficient market hypothesis. By the 1990s there had been enough “bubbles” in stock prices to remind economists of the excessive volatility of stock markets (and to prompt Federal Reserve Board chairman Alan Greenspan to point to the market’s “irrational exuberance” when share prices hit new peaks late in the decade). The securities markets seemed anything but efficient, a fact demonstrated again in 2008, when the Dow Jones Industrial Average in the U.S. lost nearly 34 percent of its value during the international financial crisis that began in the previous year. In any case, finance is an area where facts can be highly ambiguous but where the number of people desperately interested in the nature of those facts will guarantee the further growth of financial economics.

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