52 ATaleofTwoMarkets
The efficient dimension of information volatility is simply the
market’s facilitation of price changes in the light of fundamental
information about a company. That information alters the uncer-
tainty associated with that company’s future business prospects.
When the U.S. Supreme Court announces that the U.S. Food and
Drug Administration (FDA) lacks the authority to regulate tobacco
products, for example, the prices of tobacco stocks change to reflect
greater certainty about the regulatory environment.
This type of volatility is inherent in any market. It reflects the
simple reality that stoc kmar ket prices are gauges of the future value
of cash flows to shareholders. The ineradicable uncertainty in that
gauge means that prices in an efficient market will hover about the
best estimates of value. But as information changes, the degree of
uncertainty about that value changes and prices should change ac-
cordingly.
There is little reason to believe that positive information volatility
is any worse or better now than it was a decade or longer ago. On
the one hand, there may be greater uncertainty in business value as
a result of globalization, the pervasiveness of new technology, and
the seeming swiftness of its change. A portion of the substantial
price volatility of the late 1990s and early 2000s may be a function
of such greater business volatility. On the other hand, there are also
superior ways to measure business and financial risk, manage it, and
adapt to these changing landscapes. With these factors offsetting
each other, there seems little basis for saying that positive informa-
tion volatility will get better or worse in the future.
Negative information volatility is another story. This inefficient
dimension of information volatility consists of trading on the basis
of information either unrelated to fundamental values or inaccurate
about them. The stuff of negative information volatility includes age-
old accounting trickery (discussed in Chapter 9) and other tactics
designed to prop up stoc kprices, such as share repurchases (dis-
cussed in Chapter 13). But none of these problems seem more (or
less) severe than they ever did. Wacky trading strategies such as
those based on hemline levels and Super Bowl winners also consti-
tute negative information volatility, but these strategies are as fash-
ionable (and foolish) as they ever were.
What’s new is an increase in negative information volatility that
arises from trading that is based on premature information dissem-
ination, unfounded and untrue rumors, false speculative hunches,
and hopes, dreams, and lies. Changes in the manner and speed of