The Volkswagen (VW) diesel emission fraud of last year has resulted in the world's financial markets becoming more reliable for small investors, according to a New Zealand-U.S. study out Friday.
The scandal was so powerful and sustained that it fundamentally changed the way the financial markets operated, according to the study by Professor David Lont, of the University of Otago, and Professor Paul Griffin, of the University of California.
When news of the scandal broke, it wiped billions of dollars off the company's market value, forced its CEO to resign and led to multi-billion-dollar settlements, civil suits and criminal prosecutions.
Since then, other global automakers had also been exposed for massaging the fuel efficiency of their passenger cars.
The study asked why investors and financial markets did not anticipate VW's emissions fraud earlier, as several highly reputable organisations had already publicly reported their suspicions of cheating in 2013 and 2014.
But it was only after the United States Environmental Protection Agency (EPA) served VW with a notice of violation of the Clean Air Act on Sept. 18, 2015, that the company's share price plunged.
"That regulatory action also heightened investor concerns about the entire auto industry and the efficiency of both the equity and credit default swap markets," Lont said in a statement.
"It appeared that analysts and others were not delving deeper into the questionable goings-on at Volkswagen, which is required to ensure markets do capture such information efficiently."
The researcher believed that VW investors succumbed to the trap of what economists call an "informational cascade," whereby security market prices rationally reflect the common information of the large majority of investors, while also rationally ignoring the information of a few.
Eventually, the cascade is dislodged by a new public disclosure -- such as the EPA's notice of violation and VW's admission of cheating -- which unleashes a torrent of information that disrupts the financial markets.
As prices adjust, investors are left questioning why they did not see it coming.
The study of the markets for 16 of the world's largest automakers' equities and credit default swaps showed the markets became much more integrated after Sept. 18, 2015, behaving almost synchronously in their adjustment to new information.
Any lead and lag relations between credit default swap spreads and stock prices that existed before the VW scandal virtually disappeared after the scandal broke.
The ability to make profits on arbitrage trading -- buying and selling across multiple markets simultaneously to benefit from price differences -- based on the lead-lag relations also disappeared.
This led the researchers to conclude that the VW emission cheating scandal had increased capital market efficiency.
"Both conclusions are good news for the small investor, who can now increasingly rely on the financial markets to reflect all public information in automakers' prices, whether known by a few or considered by many," Griffin said in the statement.
