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The judicial view of a “reasonable investor” plays an important role in federal securities regulation, and courts express great confidence in the reasonable investor’s cognitive abilities. Behavioral economists, by contrast, do not observe real people investing in today’s markets behaving as the reasonable investors that federal securities law expects them to be. Similarly, the efficient market hypothesis (EMH) has exerted a powerful influence in securities regulation, although empirical evidence calls into question some of the basic assumptions underlying EMH. Unfortunately, to date, courts have only acknowledged the discrepancy between legal theory and behavioral economics in one situation, class certification of federal securities class actions. It is time for courts to address the gap between judicial expectations about the behavior of reasonable investors and behavioral economists’ views of investors’ cognitive shortcomings, consistent with the central purpose of federal securities regulation: protect investors from fraud.


This article was published in 44 Loy. U. Chi. L.J. 1493 (2013).