Wednesday, November 23, 2011

Triggered Budget Cuts Offer Another Test of the Efficient Markets Hypothesis

Suppose that a military contractor's earns its revenue from selling hardware to the military.  Suppose that this contractor makes a marginal piece of equipment such as those over-priced Osprey helicopters.  If the market believes that the Super-Committee in Congress will fail to come to an agreement and this triggers military cuts, then does this company's stock price decline as the "new news" that the Committee has failed becomes public knowledge?  This article says yes.  What would be an empirical test that indicates that the stock price has "over-responded" to the new news?  Perhaps these helicopters can be sold to China and the firm's stock price could rise?  We want more free international trade, don't we?