Each has an important potential bearing on financial stability and on the fair value debate:   9  4  “Excess volatility”: Some of the earliest evidence against EMH focussed on the tendency of asset prices to fluctuate more than could be justified by movements in fundamentals – so-called excess volatility. While early evidence focussed on the behaviour of equity prices, the same tests have now been applied to a wide range of asset markets, including corporate bonds, asset-backed securities and exchange  Shackle (1972) quoted in Bronk (2009). BIS Review 28/2010  rates. 10 There is overwhelming empirical evidence of excess volatility in asset prices.   “Medium-term misalignment”: Excess volatility, while inconvenient, need not by itself severely distort the functioning of capital markets. Asset prices’ signals might be noisy, but correct on average. But there is emerging evidence of asset prices becoming persistently misaligned from fundamentals in a variety of markets including equity, residential and commercial property and corporate bonds. 11    “Apparent arbitrage”: A third aspect of the failure of EMH is evidence of seemingly pure arbitrage opportunities being sustained by market participants for lengthy periods. Unlike excess volatility and misalignment, these deviations from fundamentals represent riskless opportunities to make profits. They have been evident in past, and in particular in the present, crisis. Ultimately, the importance of these three features is an empirical question. Charts 1 and 2 plot the long-run behaviour of the equity market, in the UK from the 1920s and in the US from the 1860s.

During the 19th century, the published accounts of Spanish banks became less frequent during episodes of crisis. Mussolini’s Italian government of 1931 went one step further, suspending publication of accounts by the banks to forestall panic. 14 It is unlikely Goethe and Mussolini would have agreed on the merits of double-entry. While less extreme, there is compelling evidence of British banks having massaged balance sheets from the late 19th century right up until the early 1970s, especially during crisis. Typically, this involved the systematic under-valuation of assets to allow hidden reserves to be carried on the balance sheet. The experience of UK banks in 1952 was typical. As the prices of government securities fell sharply, the basis for valuation by banks was shifted from “at or below market value” to “at or under cost”. This mirrored the Roosevelt and Bush forbearance announcements of 1938 and 1990. The motives for hidden reserves among UK banks were purportedly prudential, as protection against the “excessive dividend expectations” of shareholders and as a cushion against losses in crisis. 15 Although the Companies Act of 1947 prohibited the use of hidden reserves, the banks were exempt from its provisions. But the writing was on the wall. Non-disclosure by banks came under repeated fire during the 1960s. Sensing the inevitable, British banks “voluntarily” decided to pursue full disclosure in 1969, in the interests of shareholder transparency and protection, though there is evidence of hidden reserves persisting right up to the 1980s. 14  James (1992). 15  Billings and Capie (2009).