Taming the Animal Spirits of the Stock Markets: A Behavioral Approach to Securities Regulation

By Langevoort, Donald C. | Northwestern University Law Review, Fall 2002 | Go to article overview
Save to active project

Taming the Animal Spirits of the Stock Markets: A Behavioral Approach to Securities Regulation


Langevoort, Donald C., Northwestern University Law Review


[Our decisions] to do something positive... can only be taken as a result of animal spirits... and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.

-John Maynard Keynes, A General Theory of Employment, Interest and Money (1936).1

INTRODUCTION

The recent Enron bankruptcy is one of those rare events that brings corporate and securities law close to sustained public attention.2 It has shaken confidence that the prevailing legal norms work as well as we want, or that the marketplace imposes the kind of discipline we have assumed. Among its many puzzles is one about the stock markets. How was the market for such a widely followed stock so easily fooled, especially when (in hindsight, at least) warning signs about obscure accounting, risk-shifting, and self-dealing practices were visible?

To a skeptic about the stock markets, the Enron debacle comes as no surprise. It was an issuer-specific stock bubble, different from countless IMAGE FORMULA7

predecessors only in terms of its size and the political attention it gained. The market fell in love with the company and, like many lovers, was far too slow to realize that the object of devotion was cheating. Keynes's animal spirits were at work. The ones with the explaining to do are the believers in market efficiency, especially those whose faith is so strong in its miraculous healing powers that they think legally mandated disclosure has little role to play in investor protection.3

It is much too early to judge whether any plausible rational explanation is available as to Enron in particular, though no doubt some will be offered. Instead, this article seeks more general answers in the increasingly sophisticated debate over the validity of the efficient market hypothesis (EMH), the most venerable tenet of financial economics and a staple of contemporary legal analysis. In the form most often invoked by legal academics, the EMH teaches that the prices of the stocks of actively traded companies, like Enron, rapidly adjust to reflect the rational expectations generated by all available information as it becomes available. Stocks are consistently "rationally" priced, in other words. But faith in the EMH among economists has been weakening for some time.4 That is not new news; by the mid-- 1980s, the notion of market efficiency was already under attack by finance scholars of considerable prominence.5 Since then, however, the battle has turned into something akin to a siege. Critics are still increasing in visibility and numbers and seldom does an edition of one of the best finance journals appear without at least one or two major papers offering theoretical or empirical claims inconsistent with strong views of efficiency. Yet, the orthodox EMH adherents are far from dead and still claim sizable numbers on their side.6 As often happens with long sieges, if we look closely we see a IMAGE FORMULA9

good bit of intermarrying occurring as scholars quietly redefine efficiency or inefficiency in a way that mediates between the two camps.7

In this Article, I will explore this debate, which-as Enron shows-is profoundly important to legal academics.8 What I especially want to draw from is the most interesting development in the past decade from the EMH critics' camp. It is one thing to attack market efficiency simply by showing that empirical reality does not conform to its predictions or by offering explanations for the inconsistency. It is a more ambitious task, both empirically and theoretically, to build an alternative model of market pricing. If so-called irrational activity is simply random and unpredictable, then markets are nothing more than noisy.

However, if the nonrational properties of the securities markets reflect predictable behavioral tendencies-in other words, that the animal spirits that seemingly drive the markets are well grounded in cognitive and social psychology-then there is something more to say that might be useful to the task of securities regulation.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
Loading One moment ...
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited article

Taming the Animal Spirits of the Stock Markets: A Behavioral Approach to Securities Regulation
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

While we understand printed pages are helpful to our users, this limitation is necessary to help protect our publishers' copyrighted material and prevent its unlawful distribution. We are sorry for any inconvenience.
Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.

Are you sure you want to delete this highlight?