Measuring Market Efficiency

Measuring Market Efficiency

1. where security prices always reflect available info

   • Efficient Markets Hypothesis
     • rules out possibility of trading systems based only on currently available info being able to beat market returns
       • active managers are charlatans
     • momentum trading
       • lag effect: statistically significant in predicting future volatility
     • 0 cost trading
     • no info asym.
     • rational investors
       • Behavioural finance
         • limits to arbitrage
           • reg barriers
           • tax
           • Transaction + search costs
         • Psychology
           • cognitive biases
     • Market Microstructure Theory
       • behaviours of market participant
       • how market infra. lead to in/efficient outcomes

2. Market Integrity

   • absence of insider trading
   • absence of market manipulation
   • show confidence in the markets
     • Investors to have:
       • equal access to info
       • confidence in the price setting mechanism
       • confidence that the public info is not false or misleading
   • Market Abuse
     • lowering trading vol.
     • fewer transactions
     • prevent democratisation of finance
       • prevent access for small investors to markets
     • spoofing
       • flash trading
         • trade ahead of public market in exchange for a fee
       • spreading rumours
       • pump & dump
       • wash sales
       • cornering the market
     • MiFID Art.25
       • MS to monitor inv. firms' activities
   • Insider Trading
     • difficult to detect
     • trades where the info is material, price sensitive, not formally disclosed to the markets
     • MiFID: ESMA
     • precise nature
     • not been made public
     • relates to issuers of financial instruments
     • info has material price impact
   • Financial Integration
     • Eco. growth
       • heightened risk of fin. contagion
         • re-regulation to liberalize
       • more competition
       • Enabling portfolio diversification with access to for. markets
       • more liquid markets
     • European
       • Barriers to FT
       • capture postive ext.
       • cross-border investor protection
       • fin. market efficiency
       • Differences
         • risk preferences
         • histories
         • legal frame.
       • + market integration
       • Feldstein-Horioka puzzle
         • capital flows act to equalize marginal return on capital across nations
         • domestic (I) and (S) are highly correlated
         • Cross-border investment
           • MiFID
             • removed the concentration rules in SE & IB
               • proxy of the trade costs: diff bet/ the cost at which you want to buy and the price you sell
               • increase in trading vol.
               • trading vol. composition changed
             • consolidation of market data
     • What is it?
       • legislative measures
         • harmonization
         • supranational enforcement
       • quantitative measures
         • law of one price
           • banking sector
             • imperfectly competitive
               • high switching costs
                 • asym. info
                 • reputation
                 • barriers
               • not contestable
             • the cost of loans in EZ for borrowers with similar credit risks diverge genuinely
         • cross-border capital flows
         • assets return correlations
     • Banking Competition
       • local/geographical
         • retail
         • SME market
         • global for wholesale/investment banking
       • barriers
         • remain segmented
           • M&As + agreements
           • restrictions
           • reg. hurdles
           • for. prov. discrimination
         • non-reg
           • brand loyalty