Market Risk and Efficiency

Lessons From Financial Economics

Topics - Market Risk and Efficiency

${ numberSection } ${ text }
Lessons From Financial Economics

In Basic v. Levinson the Supreme Court adopted the fraud-on-the-market theory for securities that trade in efficient markets. The Court in its holding relied in part on the research findings of financial economists who have shown that in a wide variety of situations securities prices react very quickly to the release of new information. Unfortunately, by entertaining questions of efficiency, the Court overcomplicated its inquiry.

There is disagreement among financial economists about the meaning of efficiency, how to test for it and what the results of these tests mean. It is simply too complex to determine in a securities fraud case whether the presumption of reliance on the integrity of the market price is justified on the basis of the existence of an efficient market. Fortunately, this inquiry is also unnecessary.

We have argued that courts need not consider whether a security trades in an efficient or inefficient market; rather, courts should examine whether a misstatement caused a security to trade at an artificially high or low price. The inquiry devolves then into whether and how rapidly the market responded to the alleged misstatement. Financial economists can answer this question.

As a result, courts may avoid the almost impossible task of identifying efficiency and concentrate instead on the relatively simple task of determining the stock return associated with a misstatement and whether it is statistically significant. If so, the court should conclude that the misstatement distorted the market price — that it was material — and presume reliance.

Published in

Virginia Law Review

AQR Capital Management, LLC, (“AQR”) provide links to third-party websites only as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by us of any content or information contained within or accessible from the linked sites. If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which has no control. In no event will AQR be responsible for any information or content within the linked sites or your use of the linked sites.

The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.


Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. The hypothetical performance shown was derived from the retroactive application of a model developed with the benefit of hindsight.  Hypothetical performance results are presented for illustrative purposes only.


Diversification does not eliminate the risk of experiencing investment loss.


Certain publications may have been written prior to the author being an employee of AQR.

This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor.


AQR Capital Management is a global investment management firm, which may or may not apply similar investment techniques or methods of analysis as described herein. The views expressed here are those of the authors and not necessarily those of AQR.