Fraud on a Crazy Market

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2 Responses

  1. The class discussion that followed last time I floated this went more or less along these lines:

    -Are markets really efficient? What about noise?

    -Okay, actually, I guess they’re kind of noisy. But hey, we can deal with that, right? FOM is important.

    -But then how do you explain September / October 2008? Maybe it’s not just noise here and there. Maybe it’s deep fundamental instability.

    -Then can we ever say that markets are open and efficient? Maybe not. Maybe Basic is just broken.

    -Hmm — does Dura fix it? (Kick that around for a minute)

    -Maybe it’s time to admit that the whole idea just doesn’t work. Markets aren’t like that.

    -But wait! It’s the middle of a crisis, and you want to pull the rug out from under shareholder protections? What kind of heartless people are you, anyway?

    Eventually, we arrive at some semi-stable equilibrium that lets Basic keep living, while casting serious doubt on its rationale as stated. The process of getting there is great work for the class, and has led to very good discussions so far.

  2. David Schwartz says:

    The FOM theory is basically a form of strict liability. For example, suppose you cheat at dice. You cheat in such a way that your odds of winning go up, but it is still possible for you to lose. Maybe, for example, you substitute weighted dice that makes it more likely for you to win.

    Rather than require those you cheated to figure out how much of your winnings were due to cheating, which may not be possible, we simply make you cover all their losses. This acts as a disincentive to cheating and only punishes intentional wrongdoing.

    Basically, that’s what FOMT does. It’s a holds a cheater strictly liable for any losses without requiring the loser to prove causality because this particular type of cheating makes causality very hard to prove (and can be very indirect).