A computational view of market efficiency

Jasmina Hasanhodzic, Andrew Lo () and Emanuele Viola

Quantitative Finance, 2011, vol. 11, issue 7, 1043-1050

Abstract: We study market efficiency from a computational viewpoint. Borrowing from theoretical computer science, we define a market to be efficient with respect to resources S (e.g., time, memory) if no strategy using resources S can make a profit. As a first step, we consider memory-m strategies whose action at time t depends only on the m previous observations at times t - m, … , t - 1. We introduce and study a simple model of market evolution, where strategies impact the market by their decision to buy or sell. We show that the effect of optimal strategies using memory m can lead to 'market conditions' that were not present initially, such as (1) market spikes and (2) the possibility for a strategy using memory m' > m to make a bigger profit than was initially possible. We suggest ours as a framework to rationalize the technological arms race of quantitative trading firms.

Keywords: Agent based modelling; Bound rationality; Complexity in finance; Behavioral finance (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (6)

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Working Paper: A Computational View of Market Efficiency (2009)
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DOI: 10.1080/14697688.2010.541487

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