DOCSLIB.ORG

Should Individual Investors Use Technical Trading Rules to Attempt to Beat the Market? Thomas S

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Should Individual Investors Use Technical Trading Rules to Attempt to Beat the Market? Thomas S Sacred Heart University DigitalCommons@SHU WCOB Faculty Publications Jack Welch College of Business 2010 Should Individual Investors Use Technical Trading Rules to Attempt to Beat the Market? Thomas S. Coe Quinnipiac University Kittipong Laosethakul Sacred Heart University, [email protected] Follow this and additional works at: http://digitalcommons.sacredheart.edu/wcob_fac Part of the Business Law, Public Responsibility, and Ethics Commons, Finance and Financial Management Commons, and the Portfolio and Security Analysis Commons Recommended Citation Coe, T.S. & Laosethakul, K. (2010). Should individual investors use technical trading rules to attempt to beat the market?. American Journal of Economics and Business Administration, 2(3), 201-209. doi: 10.3844/ajebasp.2010.201.209 This Article is brought to you for free and open access by the Jack Welch College of Business at DigitalCommons@SHU. It has been accepted for inclusion in WCOB Faculty Publications by an authorized administrator of DigitalCommons@SHU. For more information, please contact [email protected]. American Journal of Economics and Business Administration 2 (3): 201-209, 2010 ISSN 1945-5488 © 2010 Science Publications Should Individual Investors Use Technical Trading Rules to Attempt to Beat the Market? 1Thomas S. Coe and 2Kittipong Laosethakul 1Department of Finance, Quinnipiac University, 275 Mount Carmel Ave. Hamden, CT 06518 USA 2Department of Accounting and Information Systems, Sacred Heart University, 5151 Park Ave., Fairfield, CT 06825 USA Abstract: Problem statement: Despite widespread academic acceptance of the Efficient Markets Hypothesis, some stock traders still use technical trading rules in an attempt to beat the market. Approach: This study looked at four trading rules, namely, the arithmetic moving average, the relative strength index, a stochastic oscillator and its moving average. These trading rules compare the relationship of current prices to past price patterns to generate a signal when to buy and sell stocks. The trading rules were tested over the years 2000-2009, a period of time that exhibited bull and bear markets, to determine if traders could actively trade a stock and beat a passive investment strategy. Results: We tested the four trading rules against the 576 stocks that comprise the S&P 100, the NASDAQ 100 and the S&P Midcap 400. The results proved discouraging to that strategy, in that no one trading rule consistently beat the market. Conclusion/Recommendations: Since technical trading rules cannot be used to consistently beat a long-term buy and hold strategy, we recommend that investors first use fundamental analysis to select stocks and then apply a technical trading rule to enhance potential trading gains. Key words: Efficient market hypothesis, moving average, relative strength index, stochastic oscillators INTRODUCTION Technical analysis, in contrast to fundamental analysis of assets, looks at the current price and relates In traditional tests of the weak-form of the this to past price history to determine the timing of Efficient Markets Hypothesis, price return differences buying and selling of stocks. The weak-form of the are found to be insufficient to develop trading rules to Efficient Markets Hypothesis states that stock prices take advantages of historical price patterns (Elton and contain all current information towards valuing the Gruber, 1995). Yet, traders continue to use technical company (Blume et al ., 1994, show that volume analysis to establish buy and sell decisions for various statistics also are significant in conveying information). Changes in prices result from changes in the supply and assets across markets. This study sets out to determine demand for the stock. There are numerous trading if there are consistently profitable techniques that can techniques available and with the increased usage of be applied for use in equities markets and compare the personal computers and on-line data services, the techniques for market-beating returns to traders who number and complexity of these techniques will surely use them. Traders, in this sense, represent individuals increase to keep pace with their proponents. However, who actively manage their positions by holding short- in the end, most trading techniques are based on taking term positions. These activities contrast to investors advantage of simple mathematical rules based on the who have a longer-term investment horizon and are tendency toward mean reversion. Simply stated, ‘what deemed more passive investors, using what is deemed a goes up must come down’ (and in most cases the naïve “buy and hold” strategy. The primary difference reverse occurs as well). in perspective is whether taking advantage of short- term price movements is more beneficial than long- Prior literature: Of the academic work studying the term price movements. effectiveness of the various trading techniques Corresponding Author: Thomas S. Coe, Department of Finance, Quinnipiac University, 275 Mount Carmel Ave., Hamden, CT 06518 USA 201 Am. J. of Economics and Business Administration 2 (3): 201-209, 2010 available, most focus on applying technical analysis and steep declines and recovery from the financial crisis and time-series tools to broad indices and not on individual global economic recession. We included the three equities. Brock et al . (1992); Gencay (1996); indices in our sample to compare the trading Bessembinder and Chan (1998) and Kwon and Kish performances of broadly-traded, high-volume listings as (2002) examine the returns on US stock market indices well as those that have less depth and trading activity. and find that technical trading provides positive There were 576 unique stocks in our sample; twenty- predictive power, in direct conflict with the weak form four of the listings were listed within both the S&P 100 of the Efficient Market Hypothesis. More recently, and the NASDAQ 100. Wong et al . (2003); Ben-Zion et al . (2003) and The time period of this study can be generally Papathanasiou and Samitas (2010) find that traders can described as mixed between a bear market, as measured exploit potential inefficiencies that arise from smaller by the S&P 500 Index, which lost 36.8% of its value and thinner international markets by using technical and a flat market, as seen with an average price trading rules. Seiler (2001) finds that an optimal filter appreciation of only $4.47 per share over this time of the Relative Strength Index (RSI) rule provides for period. The broader market began the decade at positive returns; however, his study only shows results 1455.22 and ended at 919.32. for the RSI rule and for only illustrates its use on one stock. MATERIALS AND METHODS Another line of literature, Momentum Strategy, focuses on the psychological aspect of trading. This The trading techniques we employ are the strategy assumes the pattern of trading based on events arithmetic Moving Average (MA), the Relative or economic data will continue for a period of time. If Strength Index (RSI) and a Stochastic Oscillator (K). patterns of reaction occur, then stock prices do not These are among the more popular, general techniques follow a random pattern, as has been statistically shown used by technical traders and the basis for many trading in the past. Chan et al . (1996) and Hong and Stein programs. The performance from using these trading (1998) find evidence of momentum trading with tools will be contrasted against a naive buy-and-hold regards to analysts’ earnings predictions and the strategy over the same period. subsequent earnings announcements by firms. While momentum trading is similar in essence to technical Arithmetic moving average: The arithmetic Moving trading, it relies on announcements and economic Average is the arithmetic average of prices of a stock events, while technical trading strictly abides by over the most recent period of n days: mathematical rules. The bulk of the technical analysis literature bases n− 1 P itself on the apparent visual verification on an ex post ∑ t− i MA = i= 0 basis of the gain potential of technical trading (Elder, t n 1987; Stein, 1989; Arnold, 1994; Etzkhorn, 1995). Our study broadens the literature by looking at individual stock issues, expanding the sample to that of stocks of The Moving Average generates a forecast from the various size and the overall performance of strictly past prices of a security. A Moving average that is following technical trading strategies on an ex ante increasing indicates that, on average over time, prices basis. are trending higher. The degree of sensitivity for the technique is determined by the value of n, the number Data: The sample of data used in this study includes of days in the period . If n is too small, there is too much daily high, low and closing prices from the equities that sensitivity to changes in daily prices; if n is too large, comprised the S&P 100, the NASDAQ 100 and the the Moving Average will not be sensitive enough. S&P Midcap 400 indices as of July 1, 2009. The time The trading signal generated by the moving period studied spanned a period of 9½ years; from average is determined when the current price crosses January 3, 2000 through June 30, 2009. The data allows the Moving Average line. If the current day’s closing for a broad range of stocks over a relatively long period price crosses to trade above the Moving Average line, of time so that prices will not be entirely subject to that generates a “buy” signal to traders -- demand is specific events or market conditions. The beginning of currently stronger than in the past. If the closing price this sample period saw the boom and bust of the crosses to trade below the Moving Average line, technology stocks; the effects surrounding September demand is currently weaker than in the past and that 11, 2001; the general market expansion as well as the event generates a “sell” signal to traders.
Load more

Recommended publications
  • Secondary Market Trading Infrastructure of Government Securities
    A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Balogh, Csaba; Kóczán, Gergely Working Paper Secondary market trading infrastructure of government securities MNB Occasional Papers, No. 74 Provided in Cooperation with: Magyar Nemzeti Bank, The Central Bank of Hungary, Budapest Suggested Citation: Balogh, Csaba; Kóczán, Gergely (2009) : Secondary market trading infrastructure of government securities, MNB Occasional Papers, No. 74, Magyar Nemzeti Bank, Budapest This Version is available at: http://hdl.handle.net/10419/83554 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu MNB Occasional Papers 74. 2009 CSABA BALOGH–GERGELY KÓCZÁN Secondary market trading infrastructure of government securities Secondary market trading infrastructure of government securities June 2009 The views expressed here are those of the authors and do not necessarily reflect the official view of the central bank of Hungary (Magyar Nemzeti Bank).
    [Show full text]
  • Dynamic Portfolio Optimization with Transaction Cost Abstract
    Financial Engineering and Portfolio Management / Vol.6, Issue.24, Autumn 2015 Dynamic Portfolio Optimization with Transaction Cost 1 Zahra Pourahmadi 2 Amir Abbas Najafi Receipt: 2015, 2 , 3 Acceptance: 2015, 4 , 29 Abstract The optimal selection of portfolio is one the most important decisions in managing investment funds. Several approaches have been proposed to determine what is the best trading strategy. Most of these common approaches are based on single period optimization, however, as investment is a long-term concept, such short term profit maximization cannot fully exploit the opportunities that an investor might get if he/she looks into a longer term. To this end, in this paper, we intend to extend the single-period optimization into a multi-period optimization and also, to make it more realistic, we will incorporate transaction cost in our model. To investigate the validity of the proposed scheme, we have analyzed several examples using which we have presented the steps of our approach and also statistically compared the performance of the single and multi- period optimization using Mann-Whitney U test. Based on the results of this paper, we can conclude that multi-period and single-period optimization might have similar performance if we look at short time span of the system. However the superiority of multi-period optimization becomes more evident as we extend the time span of the system which gives multi-period scheme more freedom to suggest better portfolio selections. Key Words: Portfolio, Dynamic Optimization, Transaction Cost, Investment Strategy 1 Financial Engineering Master Student, K.N. Toosi University of Technology 2 Assistant Professor, Faculty of Financial Engineering, K.
    [Show full text]
  • Performance of Stop-Loss Rules Vs. Buy-And-Hold
    LUND UNIVERSITY SCHOOL OF ECONOMICS AND MANAGEMENT NEKM01, MASTER ESSAY IN FINANCE SPRING 2009 PERFORMANCE OF STOP -LOSS RULES VS . BUY -AND -HOLD STRATEGY AUTHORS : SUPERVISOR : Bergsveinn Snorrason Göran Anderson Garib Yusupov ii ABSTRACT The purpose of this study is to investigate the performance of traditional stop-loss rules and trailing stop-loss rules compared to the classic buy-and-hold strategy. The evaluation criteria of whether stop-loss strategies can deliver better results are defined as return and volatility. The study is conducted on daily equity returns data for stocks listed on the OMX Stockholm 30 Index during the time period between January 1998 and April 2009 divided into holding periods of three months. We use the Efficient Market Hypothesis as the rule of thumb and choose an arbitrary starting date for the holding periods. We test the performance of two types of stop-loss strategies, trailing stop-loss and traditional stop-loss. Despite the methodological differences our results are in line with previous research done by Kaminski and Lo (2007), where they find that stop-loss strategies have a positive marginal impact on both expected returns and risk-adjusted expected returns. In our research we find strong indications of the stop-loss strategies being able to outperform the buy-and-hold portfolio strategy in both criteria. The empirical results indicate that the stop-loss strategies can do better than the buy-and-hold even clearer cut when compared in terms of the risk-adjusted returns. Keywords: Stop-loss, Trailing Stop-loss, Buy-and-Hold, Behavioral Finance, Strategy iii TABLE OF CONTENTS ABSTRACT ...........................................................................................................................
    [Show full text]
  • History of the Stock Market
    Contributing Writers: Douglas Alexander, Pamela Fung, NIE A Newspaper In Education Supplement to Pauline Schafer, Laura Levine News In Education What is the Stock Market? But the stock market is different from a shopping mall in some important ways. Most noticeably, you don't find all stock The Washington Times The Washington exchanges under one roof. In fact, in the United States, there are stock exchanges in many parts of the country and electronic stock markets can operate from almost any remote location. The other important difference is that at the shopping mall, stores sell products to the customers. But in the stock market, investors buy and sell stock, to and from each other. That's a bit complicated, so we'll examine it more closely, later. Sometimes we hear the stock market simply called "the mar- ket." That can be a bit confusing, since there are many types of "markets" in the world. But generally, when we hear the term on television or read it in the newspaper in the business and finance section, it's pretty safe to assume that "the mar- A Newspaper in Education Supplement to A Newspaper ket" is short for "the stock market." You may have also heard or read about "Wall Street." This is another nickname for the stock market, which comes from the actual street in New York City where the stock market, in this country, began. NEWSPAPER ACTIVITIES 1. Look through the business pages of your newspaper for how the stock market has done in the past year or two. If there is a chart that compares stock performance with bond investments or money market funds, list the relative performance of each of these types of investments.
    [Show full text]
  • L-Shares: Rewarding Long-Term Investors1
    1 L-Shares: Rewarding Long-term Investors by Patrick Bolton Columbia University and Frédéric Samama SWF Research Initiative and Amundi – Crédit Agricole Group November 2012 Abstract: We argue that a fundamental reason for the short term perspective of corporate executives is the short-term orientation of shareholders and financial markets that drive the performance benchmarks of CEOs. In our view, long-term committed shareholders can provide substantial benefits to the company they invest in and although some shareholders are prepared to take a more long-term view, they are generally not rewarded for their loyalty to the company. We believe that because they are a scarce resource and provide benefits to the company and other shareholders that have all the features of a public good, long-term shareholders need to receive financial incentives. While lengthening stock option vesting periods and introducing claw-back provisions into CEO compensation contracts help induce a more long-term orientation of CEOs, we argue that it is also necessary to reinforce this more long-term performance-based compensation with a better alignment between shareholders and CEOs horizons. Our proposal for moving towards such an alignment is to introduce Loyalty- Shares (or L-shares). These shares provide an additional reward (usually under the form of an extra-share or extra-dividend) to shareholders if they have held on to their shares for a contractually specified period of time, the loyalty period. The reward we propose, which we believe would be a more optimal solution in many cases, is in the form of a warrant giving the right to purchase a pre-determined number of new shares at a pre-specified price and granted to loyal investors at the expiration of the loyalty period.
    [Show full text]
  • International Equity Portfolios and Currency Hedging: the Viewpoint of German and Hungarian Investors*
    INTERNATIONAL EQUITY PORTFOLIOS AND CURRENCY HEDGING: THE VIEWPOINT OF GERMAN AND HUNGARIAN INVESTORS* BY GYONGYI BUGJkR AND RAIMOND MAURER ABSTRACT In this paper we study the benefits derived from international diversification of equity portfolios from the German and the Hungarian points of view. In contrast to the German capital market, which is one of the largest in the world, the Hungarian Stock Exchange is an emerging market. The Hungarian stock market is highly volatile, high returns are often accompanied by extremely large risk. Therefore, there is a good potential for Hungarian investors to realise substantial benefits in terms of risk reduction by creating multi-currency portfolios. The paper gives evidence on the above mentioned benefits for both countries by examining the performance of several ex ante portfolio strategies. In order to control the currency risk, different types of hedging approaches are implemented. KEYWORDS International Portfolio Diversification, Estimation Risk, Hedging the Currency Risk, Emerging Stock Markets. 1. INTRODUCTION Grubel (1968) was the first who extended the theoretical concepts of modern portfolio selection developed by Markowitz (1959) to an international envi- ronment. Since that time a large number of empirical studies have examined * Financial assistance from the Deutsche Forschungsgemeinschaft, SFB 504, University of Mannheim, the Landeszentralbank of Hessen, the German Actuarial Society (DAV), the Bundesverband Deutscher Investmentgesellschaften (BVI) and the Hungarian National Scientific Research Fund (OTKA F023499) are gratefully acknowledged. The authors thank the participants of the AFIR- International Colloquium 1999 in Tokyo and of the FUR IX 1999 Conference in Marrakesh for helpful comments. The Comments of the two anonymous referees improved the paper substantially.
    [Show full text]
  • The Myth of Buy and Hold
    ch01.qxp 5/25/2006 12:51 PM Page 1 1 THE MYTH OF BUY AND HOLD What do the companies Radio Corporation of America (RCA), Cisco, General Motors (GM), Trans World Airlines (TWA), Admiral, and Pan American Airways (Pan Am), have in common? These are or were sig- nificant American, for the most part New York Stock Exchange listed, corporations that have, in years past, risen to and then fallen from grace. Shares of Cisco, for example, rose from a price of 4 in 1992 to 82 in early 2000 before falling back to 8 by the end of 2004. GM, once the granddaddy of all corporations and the largest employer in the country? Priced at 11 at the bottom of the great 1973–1974 bear mar- ket, GM recovered to a price of 94 at the start of 2000, before declin- ing to 31 three years later, to lower still and near bankruptcy by the fourth quarter of 2005. Wal-Mart, with more than 1.1 million U.S. employees, has—of course—supplanted GM as the nation’s leading private employer. RCA, a pioneer in home radios and radio communication during the 1920s, rose from a price of 11 in the mid-1920s to 114 by 1 ch01.qxp 5/25/2006 12:51 PM Page 2 2 OPPORTUNITY INVESTING September 1929 before plummeting to 3 in 1932. Admiral, a hot tele- vision issue in the 1960s, met a similar fate—and never did recover. TWA and Pan Am, once investor favorites, both failed to survive shakeouts in the airline industry.
    [Show full text]
  • Buy-And-Hold Stocks That Will Make You a Fortune Now and Forever
    5 Buy-and-Hold Stocks That Will Make You a Fortune Now and Forever By Timothy Lutts, Cabot Wealth Network Why I Sent You This Free Report 5 Buy-and Hold Stocks That Will Make You a Fortune Now and Forever Dear Reader, If there is one reason that Warren Buffett, Benjamin Graham, Peter Lynch, John Templeton and John C. Bogle have become the richest and most successful investors in the world, this is it: They all identified great companies that stood directly in the path of growth, bought them, and then held them for the long term. It’s not fancy, but it works, and it eliminates a lot of risk. No longer do you have to worry about the ups and downs you see in the market daily. Because you’re in it for the long term, you no longer have to concern yourself with daily fluctuations, volatile market swings or flash crashes. My dad discovered that, too, 46 years ago, when he started Cabot Market Letter, now Cabot Growth Investor. As he told me long ago, “If you want to make money as an investor, then you want to invest in good stocks that are growing now and will continue to grow in the future.” That’s what we specialize in here at Cabot through our advisories. Sending you this report is our way of fulfilling my dad’s promise 46 years ago which is to bring our readers “the most profitable stocks on the planet” and to prove to you that buy-and-hold is one of the smartest, safest and most profitable ways to invest for your future.
    [Show full text]
  • Buy and Hold Returns
    Buy and Hold Returns Buy, Hold, and Prosper. It was a slogan used by a leading mutual fund company in the early 2000s. It made sense at the time. And why not? From 1982 to 2000 the stock market had its best run ever. Had you invested in profitable, dividend-paying stocks and been patient enough to keep them, you would have made lots of money. My favorite example is Coca Cola - a successful blue-chip company with a long history of treating its shareholders well. It may not be the most exciting stock around, but who cares? Personally I don’t invest for excitement. I invest to make money – then I spend that money on things that are exciting (like fixing my teeth and laundry room cabinets). You could have bought Coke stock for under $5* in 1990. Ten years later it was trading at just under $29. That’s quite a gain, but it is only part of the story. During that same 10 years, its dividend (cash that they pay to investors every 3 months) quadrupled. Had you invested $10,000 in Coke stock in 1990 (and kept it), the company would be paying you over $2,800/year in dividends today. But along came the year 2000 and with it the end of the 18 year ‘bull market’. An investment strategy For nearly 10 years the stock market consolidated, and Coke was no exception. you can have confidence It opened in 2000 at $28.66 and closed out 2009 at $28.50. in… That’s not to say that Coke wasn’t still a good investment.
    [Show full text]
  • Chapter 12 Supplemental Activity
    CHAPTER buying and selling 12 investments ©Vision Digital hapter 12 covers the basics of buying and selling Online Resources investments. You will learn about doing research C before you invest to help you make better choices. Personal Financial Literacy Much information about investing is available. Web site: Some information is free; some is very costly. You Data Files will also learn about many regulatory agencies. They Vocabulary Flashcards are designed to protect you, the investor, when you Beat the Clock: Buying and buy and sell securities. Selling Investments Chapter 12 Supplemental Activity Search terms: auction market discount broker over-the-counter market market order stock split stockbroker 346 Copyright 2008 Thomson Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. 12-1 Researching Investments • Describe the types of financial information outcomes found in magazines, newspapers, and newsletters. • Describe the type of data found in company reports. • Explain how to find investing information on the Internet. • List figures that can be used to compare the performance or value of companies. • Explain how investment professionals help investors. SOURCES OF INFORMATION Some people hire a stockbroker or financial planner to help them choose investments. Other people do research and make choices on their own. Either way, investors need a basic knowledge of financial markets. Keeping informed about current market conditions helps investors make better choices. Magazines Business magazines, such as BusinessWeek, Fortune, and Forbes, contain information that can be helpful to investors. In these magazines, you can read business articles and get experts’ opinions on various topics related to investing and the economy.
    [Show full text]
  • Social Finance As Cultural Evolution, Transmission Bias, and Market
    SPECIAL FEATURE: PERSPECTIVE Social finance as cultural evolution, transmission bias, and market dynamics SPECIAL FEATURE: PERSPECTIVE Erol Akçaya,1,2 and David Hirshleiferb,1,2 Edited by Andrew W. Lo, Massachusetts Institute of Technology, Cambridge, MA, and accepted by Editorial Board Member Simon A. Levin January 4, 2021 (received for review August 15, 2020) The thoughts and behaviors of financial market participants depend upon adopted cultural traits, including information signals, beliefs, strategies, and folk economic models. Financial traits compete to survive in the human population and are modified in the process of being transmitted from one agent to another. These cultural evolutionary processes shape market outcomes, which in turn feed back into the success of competing traits. This evolutionary system is studied in an emerging paradigm, social finance. In this paradigm, social transmission biases determine the evolution of financial traits in the investor population. It considers an enriched set of cultural traits, both selection on traits and mutation pressure, and market equilibrium at different frequencies. Other key ingredients of the paradigm include psychological bias, social network structure, information asymmetries, and institutional environment. evolutionary finance | cultural evolution | social interaction | behavioral economics | social finance Financial market participants employ a variety of from classical and behavioral finance, evolutionary finance, learning strategies and heuristics and are subject to and cultural evolutionary theory. We review the cultural different biases in judgments and decisions. These evolution of beliefs, investment, and price setting in finan- dispositions are shaped by the cultural traits that cial markets, in the context of social network structure and people adopt from others.
    [Show full text]
  • Efficient Capital Markets: II
    THE JOURNAL OF FINANCE * VOL. XLVI, NO. 5 * DECEMBER 1991 Efficient Capital Markets: II EUGENE F. FAMA* SEQUELSARE RARELYAS good as the originals, so I approach this review of the market efflciency literature with trepidation. The task is thornier than it was 20 years ago, when work on efficiency was rather new. The literature is now so large that a full review is impossible, and is not attempted here. Instead, I discuss the work that I find most interesting, and I offer my views on what we have learned from the research on market efficiency. I. The Theme I take the market efficiency hypothesis to be the simple statement that security prices fully reflect all available information. A precondition for this strong version of the hypothesis is that information and trading costs, the costs of getting prices to reflect information, are always 0 (Grossman and Stiglitz (1980)). A weaker and economically more sensible version of the efficiency hypothesis says that prices reflect information to the point where the marginal benefits of acting on information (the profits to be made) do not exceed the marginal costs (Jensen (1978)). Since there are surely positive information and trading costs, the extreme version of the market efficiency hypothesis is surely false. Its advantage, however, is that it is a clean benchmark that allows me to sidestep the messy problem of deciding what are reasonable information and trading costs. I can focus instead on the more interesting task of laying out the evidence on the adjustment of prices to various kinds of information. Each reader is then free to judge the scenarios where market efficiency is a good approximation (that is, deviations from the extreme version of the efficiency hypothesis are within information and trading costs) and those where some other model is a better simplifying view of the world.
    [Show full text]