Toward a theory of marginally efficient markets

Yi-Cheng Zhang

Physica A: Statistical Mechanics and its Applications, 1999, vol. 269, issue 1, 30-44

Abstract: Empirical evidence suggests that even the most competitive markets are not strictly efficient. Price histories can be used to predict near future returns with a probability better than random chance. Many markets can be considered as favorable games, in the sense that there is a small probabilistic edge that smart speculators can exploit. We propose to identify this probability using conditional entropy concept. A perfect random walk has this entropy maximized, and departure from the maximal value represents a price history's predictability. We propose that market participants should be divided into two categories: producers and speculators. The former provides the negative entropy into the price, upon which the latter feed. We show that the residual negative entropy can never be arbitraged away: infinite arbitrage capital is needed to make the price a perfect random walk.

Date: 1999
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Citations: View citations in EconPapers (32)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:phsmap:v:269:y:1999:i:1:p:30-44

DOI: 10.1016/S0378-4371(99)00077-1

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