The first edition of The Undercover Economist sported a pulp-fiction private investigator on the cover. I’d suggested the image because, well, why not? Little did I realise I was anticipating a trend: the economist as detective.
It seems an unlikely development, given the fondness of economists for convenient simplifying assumptions. (Had Sherlock Holmes been an economist, he would surely have assumed that the Hound of the Baskervilles was a perfectly spherical dog moving in a frictionless environment.)
But whether the development seems unlikely or not, “forensic economics” has arrived. A splendidly simple example was published in 1994. William Christie and Paul Schultz noticed that prices on the Nasdaq market, quoted in eighths of a dollar, actually varied by quarter-dollars. Quotes ending one-eighth, three-eighths, five-eighths and seven-eighths were rare. Christie and Schultz checked carefully before concluding that this was probably symptomatic of collusion between market-making investment banks, designed to keep bid-ask spreads plump. An investigation by the Securities and Exchange Commission, class-action lawsuits and out-of-court settlements all followed.