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Use and Misuse of Event Studies to Examine Market Efficiency

Fri Apr 30 16:24:38 EDT 2010
By Dr. David Tabak

Proof of market efficiency is often important for securities class actions because if a market is efficient, there is a rebuttable presumption that investors relied on market prices, meaning that there is no need for each potential plaintiff to demonstrate individual reliance on any misrepresentation or omission, as those would be reflected in the market price. Courts have recommended various tests, or factors to consider, to assess whether a financial market is efficient. In this paper, NERA Senior Vice President Dr. David Tabak argues that, unfortunately, the primary test that is designed to be consistent with the academic literature on market efficiency -- an examination of whether prices respond to news -- is often performed in ways that render it meaningless. In particular, the analysis has often been performed by the mere listing of examples of price responses associated with selected news events, a form of analysis that is scientifically invalid and that one court properly noted "proves nothing." Dr. Tabak reviews how this test has been implemented and discusses what different versions of the test can reveal about market efficiency.