MEASURING AND MONITORING THE EFFICIENCY OF MARKETS

Dilip B. Madan (), Wim Schoutens and King Wang
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Dilip B. Madan: Robert H. Smith School of Business, University of Maryland, College Park, MD 20742, USA
Wim Schoutens: Department of Mathematics, K.U. Leuven, Leuven, Belgium
King Wang: Derivative Product Strats, Morgan Stanley, 1585 Broadway, 5th floor, New York, 10036, USA

International Journal of Theoretical and Applied Finance (IJTAF), 2017, vol. 20, issue 08, 1-32

Abstract: Market efficiency is measured by arbitrage proximity. The level of efficiency is calibrated by extent of a distortion of probability required to neutralize the drift. Simulations of bilateral gamma models estimated from past returns deliver for each asset on each day an empirical acceptability index. The assets covered include equities, commodities, currencies, volatility and hedge fund returns. It is observed that efficiency in equity is related to the process for up moves having more frequent and smaller jumps than its down side counterpart. For commodities the situation is reversed. Volatility indices trade more efficiently than equities, commodities, or currencies. Hedge fund returns reflect lower levels of efficiency supportive of hedge funds effectively exploiting market inefficiences. The relative inefficiency of the absence of trading is noted on comparing close to open with open to close returns. Small capitalization stocks trade more efficiently than the large ones. Sector exchange traded funds trade more efficiently than the S&P 500 index. Furthermore, economic activity reflected in greater high low spreads enhance market efficiency.

Keywords: Acceptable risks; distorted expectations; bilateral gamma model; escalator elevator metric (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (9)

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DOI: 10.1142/S0219024917500510

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