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On the Impossibility of Informationally Efficient Markets
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In this paper, the authors propose a model in which there is an equilibrium degree of disequilibrium: prices reflect the information of informed individuals (arbitrageurs) but only partially, so that those who expend resources to obtain information do receive compensation.Abstract:
If competitive equilibrium is defined as a situation in which prices are such that all arbitrage profits are eliminated, is it possible that a competitive economy always be in equilibrium? Clearly not, for then those who arbitrage make no (private) return from their (privately) costly activity. Hence the assumptions that all markets, including that for information, are always in equilibrium and always perfectly arbitraged are inconsistent when arbitrage is costly. We propose here a model in which there is an equilibrium degree of disequilibrium: prices reflect the information of informed individuals (arbitrageurs) but only partially, so that those who expend resources to obtain information do receive compensation. How informative the price system is depends on the number of individuals who are informed; but the number of individuals who are informed is itself an endogenous variable in the model. The model is the simplest one in which prices perform a well-articulated role in conveying information from the informed to the uninformed. When informed individuals observe information that the return to a security is going to be high, they bid its price up, and conversely when they observe information that the return is going to be low. Thus the price system makes publicly available the information obtained by informed individuals to the uninformed. In general, however, it does this imperfectly; this is perhaps lucky, for were it to do it perfectly , an equilibrium would not exist. In the introduction, we shall discuss the general methodology and present some conjectures concerning certain properties of the equilibrium. The remaining analytic sections of the paper are devoted to analyzing in detail an important example of our general model, in which our conjectures concerning the nature of the equilibrium can be shown to be correct. We conclude with a discussion of the implications of our approach and results, with particular emphasis on the relationship of our results to the literature on "efficient capital markets."read more
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References
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Journal ArticleDOI
Efficient capital markets: a review of theory and empirical work*
TL;DR: Efficient Capital Markets: A Review of Theory and Empirical Work Author(s): Eugene Fama Source: The Journal of Finance, Vol. 25, No. 2, Papers and Proceedings of the Twenty-Eighth Annual Meeting of the American Finance Association New York, N.Y. December, 28-30, 1969 (May, 1970), pp. 383-417 as mentioned in this paper
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Expectations and the neutrality of money
TL;DR: In this article, the authors provide a simple example of an economy in which equilibrium prices and quantities exhibit what may be the central feature of the modern business cycle: a systematic relation between the rate of change in nominal prices and the level of real output.
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Linear Statistical Inference and Its Applications
TL;DR: Rao's Linear Statistical Inference and Its Applications as discussed by the authors is one of the earliest works in statistical inference in the literature and has been translated into six major languages of the world.
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On the efficiency of competitive stock markets where trades have diverse information
TL;DR: In this article, the authors consider a market with two types of traders, "informed" and "uninformed" traders, and study the operation of the price system as an aggregator of different pieces of information, and show that when there are n-types of traders (n > 1), the price reveals information to each trader which is of higher quality than his own information.
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Introduction to Mathematical Statistics
TL;DR: Paul G. Hoel's “Introduction to Mathematical Statistics” seems to me to be an excellent work, and if only it can become generally available it may have a most favourable effect on the situation just described.