Demystifying the Fraud-on-the-Market Presumption

For nearly four decades, the fraud-on-the-market presumption has played a crucial role in class-action securities fraud litigation. Despite its legal significance, the mechanics behind this presumption have largely gone unexplored in law and economics literature.

In a new paper, I introduce a simple, formal model that helps unravel the mechanisms connecting a misrepresentation to an uninformed yet active trader's reliance on the market price. The model achieves this without assuming that most investors believe stock prices reflect all public, material information, an assumption often criticized as unrealistic. Moreover, it demonstrates how a false representation can influence subsequent uninformed investors who do not fully subscribe to market efficiency.

This research not only deepens our understanding of the fraud-on-the-market presumption but also serves as a foundation for future studies. By further investigating this critical legal doctrine, researchers can develop more effective strategies for preventing and detecting securities fraud, ultimately benefiting investors and financial markets alike.

You can download the paper on my SSRN page here.