Financial markets and the state

Long swings, risk, and the scope of regulation

Roman Frydman, Michael D. Goldberg

    Research output: Contribution to journalArticle

    Abstract

    The paper makes use of an Imperfect Knowledge Economics (IKE) approach to examine the rationale and scope of state intervention in asset markets. IKE recognizes that policy officials and market participants must cope with ever-imperfect knowledge of the causal mechanism driving market outcomes. In our IKE-based model of asset markets, price swings arise from participants' diverse interpretations of the effects of fundamentals on outcomes. Under IKE, the market is an imperfect mechanism for setting values. However, the paper argues that, within a range of prices, the market's allocation is superior to the allocation that would result if the state actively intervened into the price-setting mechanism. During periods of non-excessive prices, swings play an indispensible role in helping society to allocate scarce capital and the state should confine its intervention to setting the rules of the game, that is, ensuring transparency and eliminating other market failures. However, price swings can sometimes move far from levels consistent with most perceptions of longer-term fundamental values. If they do, the IKE approach calls for active intervention to dampen excessive movements. The paper proposes the use of official "guidance ranges" and discusses problems with their estimation. It also proposes an array of other excess-countering measures and concludes with ideas on how regulators can better measure and manage systemic risk in the financial system.

    Original languageEnglish (US)
    Article number2
    JournalCapitalism and Society
    Volume4
    Issue number2
    DOIs
    StatePublished - 2009

    Fingerprint

    financial market
    regulation
    market
    economic approach
    assets
    economics
    market failure
    market price
    financial system
    transparency
    Values
    Imperfect
    Financial Markets
    Economics
    Financial markets
    interpretation
    Asset markets

    ASJC Scopus subject areas

    • History
    • Sociology and Political Science
    • Economics and Econometrics

    Cite this

    Financial markets and the state : Long swings, risk, and the scope of regulation. / Frydman, Roman; Goldberg, Michael D.

    In: Capitalism and Society, Vol. 4, No. 2, 2, 2009.

    Research output: Contribution to journalArticle

    Frydman, Roman ; Goldberg, Michael D. / Financial markets and the state : Long swings, risk, and the scope of regulation. In: Capitalism and Society. 2009 ; Vol. 4, No. 2.
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