Quantification of market efficiency based on informational-entropy

Roland Rothenstein

Papers from arXiv.org

Abstract: Since the 1960s, the question whether markets are efficient or not is controversially discussed. One reason for the difficulty to overcome the controversy is the lack of a universal, but also precise, quantitative definition of efficiency that is able to graduate between different states of efficiency. The main purpose of this article is to fill this gap by developing a measure for the efficiency of markets that fulfill all the stated requirements. It is shown that the new definition of efficiency, based on informational-entropy, is equivalent to the two most used definitions of efficiency from Fama and Jensen. The new measure therefore enables steps to settle the dispute over the state of efficiency in markets. Moreover, it is shown that inefficiency in a market can either arise from the possibility to use information to predict an event with higher than chance level, or can emerge from wrong pricing/ quotes that do not reflect the right probabilities of possible events. Finally, the calculation of efficiency is demonstrated on a simple game (of coin tossing), to show how one could exactly quantify the efficiency in any market-like system, if all probabilities are known.

Date: 2018-12
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://arxiv.org/pdf/1812.02371 Latest version (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1812.02371

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().