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The Stock Market Speaks: How Dr. Alchian Learned to Build the Bomb
Abstract
At RAND in 1954, Armen A. Alchian conducted the world’s first event study to infer the fissile fuel material used in the manufacturing of the newly-developed hydrogen bomb. Successfully identifying lithium as the fissile fuel using only publicly available financial data, the paper was seen as a threat to national security and was immediately confiscated and destroyed. The bomb’s construction being secret at the time but having since been partially declassified, the nuclear tests of the early 1950s provide an opportunity to observe market efficiency through the dissemination of private information as it becomes public. I replicate Alchian’s event study of capital market reactions to the Operation Castle series of nuclear detonations in the Marshall Islands, beginning with the Bravo shot on March 1, 1954 at Bikini Atoll which remains the largest nuclear detonation in US history, confirming Alchian’s results. The Operation Castle tests pioneered the use of lithium deuteride dry fuel which paved the way for the development of high yield nuclear weapons deliverable by aircraft. I find significant upward movement in the price of Lithium Corp. relative to the other corporations and to DJIA in March 1954; within three weeks of Castle Bravo the stock was up 48% before settling down to a monthly return of 28% despite secrecy, scientific uncertainty, and public confusion surrounding the test; the company saw a return of 461% for the year.
... When word of the paper reached the Pentagon, the paper was confiscated, at the behest of the Defense Department, was confiscated from Alchian and destroyed. Newhard (2014) recounts the incident and reconstructs Alchian's event study. 16 Such interactions give rise to the indeterminacy exemplified by the Holmes-Moriarity interaction discussed above. ...
Hayek was among the first to realize that for intertemporal equilibrium to obtain all agents must have correct expectations of future prices. Before comparing four categories of intertemporal, the paper explains Hayek’s distinction between correct expectations and perfect foresight. The four equilibrium concepts considered are: (1) Perfect foresight equilibrium of which the Arrow-Debreu-McKenzie (ADM) model of equilibrium with complete markets is an alternative version, (2) Radner’s sequential equilibrium with incomplete markets, (3) Hicks’s temporary equilibrium, as extended by Bliss; (4) the Muth rational-expectations equilibrium as extended by Lucas into macroeconomics. While Hayek’s understanding closely resembles Radner’s sequential equilibrium, described by Radner as an equilibrium of plans, prices, and price expectations, Hicks’s temporary equilibrium seems to have been the natural extension of Hayek’s approach. The now dominant Lucas rational-expectations equilibrium misconceives intertemporal equilibrium, suppressing Hayek’s insights thereby retreating to a sterile perfect-foresight equilibrium.
Hayek was among the first to realize that, in intertemporal equilibrium, all agents must have correct expectations of future prices. Before comparing four categories of intertemporal equilibrium—(1) Perfect-foresight equilibrium, (2) Radner’s sequential equilibrium with incomplete markets, (3) Hicks’s temporary equilibrium, as extended by Bliss; (4) the Muth rational-expectations equilibrium, as extended by Lucas into macroeconomics—the chapter explores the distinction between correct and perfect foresight. While Hayek’s understanding closely resembles Radner’s sequential equilibrium, described by Radner as an equilibrium of plans, prices, and price expectations, Hicks’s temporary equilibrium seems to have also been a natural extension of Hayek’s approach. The now dominant Lucas rational-expectations equilibrium misconceives intertemporal equilibrium, suppressing Hayek’s insights and retreating to a sterile perfect-foresight equilibrium.
Along with Erik Lindahl and Gunnar Myrdal, F. A. Hayek was among the first to realize that the necessary conditions for intertemporal, as opposed to stationary, equilibrium could be expressed in terms of correct expectations of future prices, often referred to as perfect foresight. Subsequently, J. R. Hicks further elaborated the concept of intertemporal equilibrium in Value and Capital in which he also developed the related concept of a temporary equilibrium in which future prices are not correctly foreseen. This paper attempts to compare three important subsequent developments of that idea with Hayek's 1937 refinement of his original 1928 paper on intertemporal equilibrium. As a preliminary, the paper explains the significance of Hayek's 1937 distinction between correct expectations and perfect foresight. In non-chronological order, the three developments of interest are: (1) Roy Radner's model of sequential equilibrium with incomplete markets as an alternative to the Arrow-Debreu-McKenzie model of full equilibrium with complete markets; (2) Hicks's temporary equilibrium model, and an important extension of that model by C. J. Bliss; (3) the Muth rational-expectations model and its illegitimate extension by Lucas from its original microeconomic application into macroeconomics. While Hayek's 1937 treatment most closely resembles Radner's sequential equilibrium model, which Radner, echoing Hayek, describes as an equilibrium of plans, prices, and price expectations, Hicks's temporary equilibrium model would seem to have been the natural development of Hayek's approach. The now dominant Lucas rational-expectations approach misconceives intertemporal equilibrium and ignores the fundamental Hayekian insights about the meaning of intertemporal equilibrium.
Asset prices are much more volatile during exchange trading hours than during non-trading hours. This paper considers three explanations for this phenomenon: (1) volatility is caused by public information which is more likely to arrive during normal business hours; (2) volatility is caused by private information which affects prices when informed investors trade; and (3) volatility is caused by pricing errors that occur during trading. Although a significant fraction of the daily variance is caused by mispricing, the behavior of returns around exchange holidays suggests that private information is the principle factor behind high trading-time variances.
There is an impressive body of empirical evidence which indicates that successive price changes in individual common stocks are very nearly independent. Recent papers by Mandelbrot and Samuelson show rigorously that independence of successive price changes is consistent with an efficient market, i.e., a market that adjusts rapidly to new information. It is important to note, however, that in the empirical work to date the usual procedure has been to infer market efficiency from the observed independence of successive price changes. There has been very little actual testing of the speed of adjustment of prices to specific kinds of new information. The prime concern of this paper is to examine the process by which common stock prices adjust to the information (if any) that is implicit in a stock split. In doing so we propose a new event study methodology for measuring the effects of actions and events on security prices.
We provide evidence on the speed and accuracy of price discovery by studying stock returns and trading volume surrounding the crash of the space shuttle Challenger. While the event was widely observed, it took several months for an esteemed panel to determine which of the mechanical components failed during the launch. By contrast, in the period immediately following the crash, securities trading in the four main shuttle contractors seemingly singled out the firm that manufactured the faulty component. We show that price discovery occurred without large trading profits and that much of the price discovery occurred during a trading halt of the firm responsible for the faulty component. Finally, although we document what are arguably quick and accurate movements of the market, we are unable to detect the actual manner in which particular informed traders induced price discovery.
Research on this project was supported by a grant from the National Science Foundation. I am indebted to Arthur Laffer, Robert Aliber, Ray Ball, Michael Jensen, James Lorie, Merton Miller, Charles Nelson, Richard Roll, William Taylor, and Ross Watts for their helpful comments.
We analyze the extent to which simple markets can be used to aggregate
disperse information into efficient forecasts of uncertain future
events. Drawing together data from a range of prediction contexts,
we show that market-generated forecasts are typically fairly accurate,
and that they outperform most moderately sophisticated benchmarks.
Carefully designed contracts can yield insight into the marketâs
expectations about probabilities, means and medians, and also uncertainty
about these parameters. Moreover, conditional markets can effectively
reveal the marketâs beliefs about regression coefficients, although
we still have the usual problem of disentangling correlation from
causation. We discuss a number of market design issues and highlight
domains in which prediction markets are most likely to be useful.
The distance between small firms and their lenders is increasing, and they are communicating in more impersonal ways. After documenting these systematic changes, we demonstrate they do not arise from small firms locating differently, consolidation in the banking industry, or biases in the sample. Instead, improvements in lender productivity appear to explain our findings. We also find distant firms no longer have to be the highest quality credits, indicating they have greater access to credit. The evidence indicates there has been substantial development of the financial sector, even in areas such as small business lending. SMALL BUSINESS LENDING HAS HISTORICALLY been very costly, because of the pau
This paper argues that an important part of movements in asset prices may be caused by neither external news nor irrationality but by the revelation of information by the trading process itself. Two models are developed that illustrate this general idea. One model is based on investor uncertainty about the quality of other investors' information; the other is based on dispersion of information and small costs to trading. The analysis is used to suggest a possible rational explanation of the October 1987 crash. Copyright 1993 by American Economic Association.
The dynamic behavior of security prices is studied in a setting where two agents trade strategically and learn over time from market prices. The model introduces an information structure that is intended to capture the notion that information is difficult to interpret. Strategic interaction and the complexity of the information result in a protracted price response. Equilibrium price paths of the model may display reversals in which the two traders rationally revise their beliefs, first in one direction and then in the opposite direction, even though no new information has entered the system. Copyright 1993 by Royal Economic Society.
SEQUELS ARE RARELY AS good as the originals, so I approach this review of the market efficiency literature with trepidation. The task is thornier than it was 20 years ago, when work on efficiency was rather new. The literature is now so large that a full review is impossible, and is not attempted here. Instead, I discuss the work that I find most interesting, and I offer my views on what we have learned from the research on market efficiency.
The Intellectual Portrait Series: A Conversation with Armen A Principles of Professional Advancement. The Collected Works of Armen A Uncertainty, Evolution, and Economic Theory. The Collected Works of Armen A. Alchian. Liberty Fund
- Alchian
- Armen
Alchian, Armen A., 2000. The Intellectual Portrait Series: A Conversation with Armen A. Alchian. Liberty Fund, Indianapolis. Alchian, Armen A., 2006. Principles of Professional Advancement. The Collected Works of Armen A. Alchian. Liberty Fund, Indianapolis Alchian, Armen A., 2006. Uncertainty, Evolution, and Economic Theory. The Collected Works of Armen A. Alchian. Liberty Fund, Indianapolis Armagnac, Alden P, 1952. Lithium: The H-Bomb Metal. Popular Science, September 1952