The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business. . . .

Of late, it’s not so easy to tell this to my law students with a straight face. Last year saw the market lurch like a madman, dropping almost 2000 points in one week alone, and nearly 800 points in one day. That doesn’t look like a market that’s open and efficient (and perhaps just a bit noisy here and there); that looks more like a market [...]]]> Basic v. Levinson clearly sets out the theoretical justification for the fraud on the market theory:

The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business. . . .

Of late, it’s not so easy to tell this to my law students with a straight face. Last year saw the market lurch like a madman, dropping almost 2000 points in one week alone, and nearly 800 points in one day. That doesn’t look like a market that’s open and efficient (and perhaps just a bit noisy here and there); that looks more like a market that was completely out of whack.

The problem with Basic is well known, and commenters like Larry Ribstein have suggested various solutions (such as more careful focus on causation issues) to combat general noisiness.

But is there a solution that addresses complete insanity? Try asking this one in class some time, and just listen to the discussion that follows.