Monday, September 11, 2006

Using Economics to Put People in Jail

The Economics Focus in this week's issue of The Economist discusses how the "efficient markets hypothesis" is used in legal cases. Again, we are getting a little ahead of ourselves in the curriculum, but the "efficient markets hypothesis," as applied to the stock market, basically says that the price of a stock includes all of the public information relevant to its value. Therefore, the only reason a stock changes price is because of new information.

You can turn the hypothesis around and measure how much impact an event has on the stock price by determining how much the stock went up or down when the news came out about the event. This hypothesis was used in the legal case of a tax accountant named James Olis
His 24-year sentence stemmed from a calculation of the financial loss caused to investors in Dynegy by Project Alpha, an accounting fraud in which he took part. That financial loss was estimated using the fall in Dynegy's share price on the news that Project Alpha was fraudulent. According to Judge Lake, it was so big that, under sentencing guidelines then in place, Mr Olis had to go to jail for a long time.
Any thoughts on the use of this theory to determine damages? The article discusses some of the controversy of using it.

(Source: Freakonomics Blog)


Anonymous said...

This is extremely confusing to me, but i am willing to give it a shot: basically, this article is proposing that news of fraudulentcy in Project Alpha caused an extreme loss caused by James Olis's actions. In turn, someone calculated how much the news impacted the financial situation caused by Olis to reveal the amount of time (or cost for his actions) that he has to spend behind bars. That is my interpretation, so i have to base my argument/opinion on that interpretation. I think that public information has an extremely large impact on stock prices--with new information, that is a change in consumer preferences, which shifts the demand curve (in this case, right), which ultimalty causes a decrease in quanity demanded. News like fradulency will cause damages for this accounting firm, which can ultimaltey damage their reputation overall. This "efficient markets hypothesis" seems accurate in many ways, but not in others. Would a decrease in income cause less people to pay for accounting services, rather do their own tax accounts or use internet services instead? i dont know if this hypothesis would apply for all cases, but in this one, i believe the impact is extreme-popular opinions and such deteremine the demand for goods and services just as much as anything else, if not more, as reputation is extremely important. Damages could be determined based on this theory, but without the theory, damages would probably need to be calculated through other means.

Anonymous said...

^^Alena, sorry!