A New Measure of Market Inefficiency

Christopher R. Stephens, Harald A. Benink, José Luís Gordillo and Juan Pablo Pardo-Guerra
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Christopher R. Stephens: C3-Centro de Ciencias de la Complejidad, Instituto de Ciencias Nucleares, Universidad Nacional Autónoma de México, Ciudad de México 04510, Mexico
Harald A. Benink: School of Economics and Management, Tilburg University, PO Box 90153, 5000 LE Tilburg, The Netherlands
José Luís Gordillo: C3-Centro de Ciencias de la Complejidad, Instituto de Ciencias Nucleares, Universidad Nacional Autónoma de México, Ciudad de México 04510, Mexico
Juan Pablo Pardo-Guerra: Department of Sociology, University of California San Diego, 9500 Gilman Dr, La Jolla, CA 92093, USA

JRFM, 2021, vol. 14, issue 6, 1-22

Abstract: Financial crises, such as the Great Financial Crisis of 2007–2009 and the COVID-19 Crisis of 2020–2021, lead to high volatility in financial markets and highlight the importance of the debate on the Efficient Markets Hypothesis, a corollary of which is that in an efficient market it should not be possible to systematically make excess returns. In this paper, we discuss a new empirical measure—Excess Trading Returns—that distinguishes between market and trading returns and that can be used to measure inefficiency. We define an Inefficiency Matrix that can provide a complete, empirical characterization of the inefficiencies inherent in a market. We illustrate its use in the context of empirical data from a pair of model markets, where information asymmetries can be clearly understood, and discuss the challenges of applying it to market data from commercial exchanges.

Keywords: efficient market hypothesis (EMH); excess trading returns; investor’s behaviour; behavioural finance (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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