We provide evidence on the speed and accuracy of price discovery by studying stock returns and trading volume surrounding the crash of the space shuttle Challenger. While the event was widely observed, it took several months for an esteemed panel to determine which of the mechanical components failed during the launch. By contrast, in the period immediately following the crash, securities trading in the four main shuttle contractors seemingly singled out the firm that manufactured the faulty component. We show that price discovery occurred without large trading profits and that much of the price discovery occurred during a trading halt of the firm responsible for the faulty component. Finally, although we document what are arguably quick and accurate movements of the market, we are unable to detect the actual manner in which particular informed traders induced price discovery.In other words, the market was able to figure out what went wrong before the scientists did.
Sunday, November 01, 2009
The Market Knows Best
One of the main complaints against capitalism is the unwieldy power "the market" has. Stocks go up or down seemingly at random, speculative bubbles burst affecting even those not investing, businesses distort prices to victimize consumers, etc. These all too often misunderstandings of the free market forget that "the market" is simply a result the combined preferences of consumers and relative scarcity. Gold is more expensive than iron because the collective preferences of buyers prefer the attractiveness of gold. Anytime the government tries to regulate these prices (taxes, subsidies, minimum wage, etc) they confuse the information embedded in them. What's most amazing is the combined wisdom of market agents can give us a lot of information even before we know what it is. Here's a great example from an old college professor of mine: