Document Type

Article

Publication Date

11-2016

Keywords

Market efficiency, Derivatives, Efficient Market Hypothesis

Disciplines

Banking and Finance Law | Securities Law

Abstract

These are not your parents' financial markets. A generation ago, the image of Wall Street was one of floor traders and stockbrokers, of opening bells and ticker symbols, of titans of industry and barbarians at the gate. These images reflected the prevailing view in which stock markets stood at the center of the financial universe. The high point of this equity-centric view coincided with the development of a significant body of empirical literature examining the efficient market hypothesis (EMH): the prediction that prices within an efficient stock market will fully incorporate all available information. Over time, this equity-centric view became conflated with these empirical findings, transforming the EMH in the eyes of many observers from a testable prediction about how rapidly new information is incorporated into stock prices into a more general--and generally unexamined--statement about the efficiency of financial markets.

This Article examines the mechanisms of derivatives market efficiency. These mechanisms respond to information and other problems not generally encountered within conventional stock markets. These problems reflect important differences in the nature of derivatives contracts, the structure of the markets in which they trade, and the sources of market liquidity. Predictably, these problems have led to the emergence of very different mechanisms of market efficiency. This Article describes these problems and evaluates the likely effectiveness of the mechanisms of derivatives market efficiency. It then explores the implications of this evaluation in terms of the current policy debates around derivatives trade reporting and disclosure, the macroprudential surveillance of derivatives markets, the push toward mandatory central clearing of derivatives, the prudential regulation of derivatives dealers, and the optimal balance between public and private ordering.

Comments

This article predates the author's affiliation with Cornell Law School.

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