Efficient Market Hypothesis

When is a market efficient? According to some, it is efficient if a person without insider knowledge is unable to predict future prices: future market prices follow a random walk. Most people believe financial markets are reasonably efficient in this sense. Unfortunately, efficient markets were also defined differently. A whole lot of economists claimed that financial markets priced assets “correctly”. They were supposed to reflect long run fundamentals such as future earning power. The dot-com-bubble wasn’t enough to explode this myth. Will the current financial crisis persuade analysts that asset prices follow a random walk: the pattern of the drunk on the way home?

Performance Incentives

Performance incentives are a central element of an economist's policy toolkit. These incentives consist exclusively of material rewards. Even economists grudgingly agree that most people are motivated not only by monetary gain but also by social norms, such as by doing a good job or by intrinsic job satisfaction. Bitterly fought however is the well-established insight that monetary rewards often undermine these other motivators and, as a consequence, additional monetary rewards may reduce performance.

Rating Agencies

Rating agencies pretend to assess the future creditworthiness of firms and governments. Barred from knowing the future they assess current creditworthiness and utter expensively what everybody gets from news anyway: They upgrade when news are good and downgrade when news are bad. Still, there are sufficient fools to be fleeced to make rating a lucrative business.