Informational Efficiency Of Prices Research Articles

Costly Information Acquisition in Decentralized Markets: Experimental Evidence

This study tests the rationality of the decisions to purchase information, the informational efficiency of prices, and the optimality of the resulting allocations in decentralized markets with a series of laboratory experiments. The theory predicts that markets with dispersed information and natural buyers and sellers converge to a fully revealing equilibrium. It is profitable to pay for information, and as such, the Grossman-Stiglitz paradox does not emerge. Statistically significant improvements in both price efficiency and allocative efficiency are documented across trading periods. In contrast to the theory, which predicts that the higher the number of informed agents, the stronger the individual incentives to invest in information, the and the more data present the opposite result. The price of information is higher when there are fewer informed agents. The result can be explained by boundedly rational decision making. This paper was accepted by Yan Chen, behavioral economics and decision analysis. Funding: This work was supported by the National Science Foundation [Price Quality in Dark Markets Grant 1426428]. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2023.4976 .

Passive blockholders, informational efficiency of prices, and firm value

AbstractThis paper analyzes the role of passive blockholders in corporate governance using data on Schedule 13G filings. We show that firm value increases with the number and aggregate ownership of passive blockholders after controlling for other possible determinants of firm value. More importantly, we show that the informational efficiency of prices (IEP) increases with the number and aggregate ownership of passive blockholders, and IEP is a channel through which passive blockholders affect firm value. Overall, our results suggest that managers perform better when stock prices reflect the economic consequences of their actions promptly and accurately through information‐based trading of blockholders.

Passive Blockholders, Informational Efficiency of Prices, and Firm Value

This paper analyzes the role of passive blockholders in corporate governance using data on Schedule 13G filings. We show that firm value increases with the number and aggregate ownership of passive blockholders after controlling for other possible determinants of firm value. More importantly, we show that the informational efficiency of prices (IEP) increases with the number and aggregate ownership of passive blockholders, and IEP is a channel through which passive blockholders affect firm value. Overall, our results suggest that managers perform better when stock prices reflect the economic consequences of their actions promptly and accurately through information-based trading of blockholders.

Costly Information Acquisition in Decentralized Markets: An Experiment

In a series of controlled laboratory experiments, we test the rationality of the decisions to purchase information, the informational efficiency of prices and the optimality properties of the resulting allocations in a decentralized markets. The theory predicts that markets with dispersed information and identifiable buyers and sellers converge to a fully revealing equilibrium. It is profitable to pay for information and as such, the Grossman-Stiglitz paradox does not emerge. We find statistically significant improvements for both price efficiency and allocational efficiency in the course of the experiment. The participants remain willing to pay for information, in contrast with centralized markets, where information effectively aggregates very fast (Plott and Sunder (1988)), and where the information auction price drops to zero (Sunder (1992)).

Rational Mispricing with Unpredictable Demand Shocks

Movements in prices depend both on innovations to cashflows and changes in investors' demands, which can be modelled as fluctuations in the cross-sectional distribution of wealth across a fixed set of investment objectives. This paper explores the risk that arises when investors do not have perfect information about the wealth distribution to accurately forecast demand shocks, and, as a result, cannot forecast prices accurately, despite having perfect information about cashflows. To take into account this risk, investors plan their consumption for all realisations of the wealth distribution that are possible according to their subjective beliefs about the wealth distribution. This makes markets highly incomplete, and derivative assets become non-redundant. Derivatives serve a dual purpose: they allow investors to adjust consumption for different realisations of the wealth distribution, and provide information required to implement optimal allocation decisions. Asset prices depend on the sensitivity of stochastic discount factor and assets' payoffs to the wealth distribution, creating differences in expected returns between assets that are unrelated to their cashflow risk. Prices of derivatives deviate from the expected cost of creating synthetic derivatives through dynamic trading, creating apparent mispricings between derivatives and primary assets. The imprecise information about the wealth distribution can also induce a demand for dynamic trading, leaving passive investment strategies no longer optimal. Our results also have implications for arbitrage activity, informational efficiency of prices, and the role of financial innovation.

Corporate Governance and the Informational Efficiency of Prices

We explore the relation between corporate governance and the informational efficiency of prices (IEP). We find that IEP increases with the quality of corporate governance in a large cross‐section of firms. We show that firms with better governance structures file Form 8‐K reports more promptly and have more accurate analysts’ earnings forecasts, suggesting that corporate voluntary disclosures and analyst forecasts are channels through which corporate governance affects IEP. The positive relation between IEP and governance quality cannot be attributed to reverse causality or other confounding factors (e.g., analyst following, stock market liquidity, and institutional ownership). On the whole, our results show that better governance structures lead to higher IEP by improving the speed and extent of corporate information disclosures.

Corporate Governance and the Informational Efficiency of Prices

We explore the relation between corporate governance and the informational efficiency of prices (IEP). We find that IEP increases with the quality of corporate governance in a large cross-section of firms. We show that firms with better governance structures file Form 8-K reports more promptly and have more accurate analysts’ earnings forecasts, suggesting that corporate voluntary disclosures and analyst forecasts are channels through which corporate governance affects IEP. The positive relation between IEP and governance quality cannot be attributed to reverse causality or other confounding factors (e.g., analyst following, stock market liquidity, and institutional ownership). On the whole, our results show that better governance structures lead to higher IEP by improving the speed and extent of corporate information disclosures.

Insider Trade Disclosure, Market Efficiency, and Liquidity

Is a more transparent market also more efficient and liquid? We address this question by analyzing the impact of mandatory ex-post disclosure of corporate insider trades in a dynamic model of strategic risk averse insider trading. We show that trade disclosure reduces informational efficiency of prices, may cause the market to be less liquid, and may even increase insiders’ expected utility. In a more transparent market, the informed trader uses a less aggressive trading strategy in order to prevent the market maker from perfectly inferring the private information from public records, and to maintain her informational advantage over time. Our results then question the effectiveness of disclosure regulations.

Speed of convergence to market efficiency: The role of ECNs

Abstract Chordia, Roll and Subrahmanyam (2005, CRS) estimate the speed of convergence to market efficiency based on short-horizon return predictability of the 150 largest NYSE firms. We extend CRS to a broad panel of NYSE stocks and are the first to examine the relation between electronic communication networks (ECNs) and the corresponding informational efficiency of prices. Overall, we confirm CRS's result that price adjustments to new information occur on average within 5–15 min for large NYSE stocks. We further show that it takes about 20 min longer for smaller firms to incorporate information into prices. Most importantly, we demonstrate that the speed of convergence to market efficiency is significantly related to the type of trading platform where orders are executed, even after controlling for relative order flows, trading costs, volatility, informational effects, trading conditions, market quality, institutional trading activity, and other firm-specific characteristics. Our findings provide direct answers and insights to issues raised in a recent SEC concept release document.

Speed of Convergence to Market Efficiency: The Role of ECNs

Chordia, Roll and Subrahmanyam (2005, CRS) estimate the speed of convergence to market efficiency based on short-horizon return predictability of the 150 largest NYSE firms. We extend CRS to a broad panel of NYSE stocks and are the first to examine the relation between electronic communication networks (ECNs) and the corresponding informational efficiency of prices. Overall, we confirm CRS’s result that price adjustments to new information occur on average within five to fifteen minutes for large NYSE stocks. We further show that it takes about twenty minutes longer for smaller firms to incorporate information into prices. Most importantly, we demonstrate that the speed of convergence to market efficiency is significantly related to the type of trading platform where orders are executed, even after controlling for relative order flows, trading costs, volatility, informational effects, trading conditions, market quality, institutional trading activity, and other firm-specific characteristics. Our findings provide direct answers and insights to issues raised in a recent SEC concept release document.

Originate-to-Distribute and Screening Incentives

Conventional wisdom holds that lax screening during the subprime boom was the inevitable result of the originate-to-distribute (OTD) business model under which originators retain zero interest in complex tranched securities (CDOs). This has led to calls for originators to maintain more skin-in-the-game (SITG) and curbs on CDOs. We examine these claims in a fully rational model where originators first choose screening effort and then use private information regarding value in deciding between signaling via retentions versus pooling at OTD cum optimally structured CDOs. Contrary to conventional wisdom, we show screening incentives can actually be stronger under OTD, but only if two conditions are met: orginators attach high value to immediate funding and informed trading drives prices sufficiently close to fundamentals. We argue that lax lending standards during the subprime boom can be understood as arising endogenously from insufficient informed trading in CDO markets. Limits on tranched CDOs are shown to be misguided. Tranching creates Arrow securities demanded by hedgers who serve as trading partners for informed speculators who drive prices closer to fundamentals. We also show that screening and no screening by originators can be self-fulfilling prophecies as changes in the probability distribution of CDO quality shift incentives for information acquisition. Finally, we show that bans on shorting alter speculator trading capital needs, decreasing (increasing) the informational efficiency of prices if the unconditional expected quality is high (low).

Institutional Investors and the Informational Efficiency of Prices

Institutional Investors and the Informational Efficiency of Prices

How Noise Trading Affects Markets: An Experimental Analysis

We use a laboratory market to investigate the behavior of noise traders and their impact on the market. Our experiment features informed traders (who possess fundamental information), liquidity traders (who have to trade for exogenous reasons), and noise traders (who do not possess fundamental information and have no exogenous reasons to trade). We find differences in behavior between liquidity traders and noise traders, justifying their separate treatment. We find that noise traders exert some positive effects on market liquidity: volume and depths are higher and spreads are lower. We provide evidence suggesting that the main effect of the liquidity-enhancing trading strategies of the noise traders is to weaken price reversals (decreasing the temporary price impact of market orders) rather than to reduce the permanent price impact of trades (as liquidity traders supposedly do in market microstructure models with information asymmetry). We find that noise traders adversely affect the informational efficiency of the market, but only when the extent of adverse selection is large (i.e., when informed traders have very valuable private information). Finally, we examine how trader behavior and certain market quality measures are affected by a transaction tax. Although such taxes do reduce noise trader activity, they take a toll on informed trading as well. As a result, while taxes reduce volume, they do not affect spreads and price impact measures, and have at most a weak effect on the informational efficiency of prices.

Lifting the Veil: An Analysis of Pre‐trade Transparency at the NYSE

ABSTRACTWe study pre‐trade transparency by looking at the introduction of NYSE's OpenBook service that provides limit‐order book information to traders off the exchange floor. We find that traders attempt to manage limit‐order exposure: They submit smaller orders and cancel orders faster. Specialists' participation rate and the depth they add to the quote decline. Liquidity increases in that the price impact of orders declines, and we find some improvement in the informational efficiency of prices. These results suggest that an increase in pre‐trade transparency affects investors' trading strategies and can improve certain dimensions of market quality.

Lifting the Veil: An Analysis of Pre-trade Transparency at the NYSE

We study pre-trade transparency by looking at the introduction of NYSE's OpenBook service that provides limit order book information to traders off the exchange floor. We find that traders attempt to manage limit order exposure: They submit smaller orders and cancel orders faster. Specialists' participation rate and the depth they add to the quote decline. Liquidity increases in that the price impact of orders declines, and we find some improvement in the informational efficiency of prices. These results suggest that an increase in pre-trade transparency affects investors' trading strategies and can improve certain dimensions of market quality.