December 1, 2006

Does the Market Self-Correct?

Asymmetrical Adjustment and the Structure of Economic Error
  • Christopher Coyne

    Associate Director, F. A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics
  • Peter J. Boettke

    Director, F. A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics
  • Peter Leeson

    Senior Fellow, F. A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics
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While both errors of overoptimism and errors of overpessimism are possible in the face of imperfect information, the presence of option value from deferring a decision to exchange causes trader errors to be overpessimistically biased. This is problematic because, unlike errors of overoptimism, errors of overpessimism are not 'automatically' revealed to the agents who make them. Furthermore, owing to the 'bad news principle of irreversible investment,' these errors are likely to persist. This paper shows how entrepreneurial activity corrects such errors and prevents their persistence, creating a tendency towards market efficiency despite the presence of imperfect information.

Read the article at Taylor & Francis Online.

Citation: Christopher Coyne, Peter Boettke, and Peter Leeson, "Does the Market Self-Correct?
: Asymmetrical Adjustment and the Structure of Economic Error." Review of Political Economy, Vol 18, No. 1, pp. 79-90, January 2006.