How efficient are equity markets? No, not in the EMH sense.
My take is that market efficiency viewed from economics/finance is about total surplus maximization—the area between the supply and demand curves. Clearly when S and D are order schedules and P and Q correspond to the S&D intersection one maximizes the area of the triangle defined in the graph.
But existing equity markets don’t work off an ordered schedule but largely match trades in a somewhat random order—people place orders (bids and offers) throughout the day and as they come in during market hours trades occur.
Given these are pure pecuniary markets the total surplus represents something of a total profit in the market for the day’s activities (clearly something different than the total profits to the actual share owners who sold so calling it profit might be a bit confusing). One might think markets should be structured to maximize that area but clearly that is not the case.
It would be a very unsual case for the daily order flow to perfectly match with the implied day demand and supply curves that would represent the bids and offers (lets call them the “real” bids and offers but I’m not entirely sure how to distinquish that from other bids and offers that will start evaporating as soon as they become the market bid or offer). So would a settlement structure line mutual funds produce a better outcome for equities?
Maybe. In other words, rather than putting a market order in and having it executed right then or putting a limit order in and if the market moves to that price it executes, all orders get put in the order book and then at market close the clearing price is determed and those trades that actually make sense occur. What is prevented is the case of either buyers above the clearlin price from getting paired with sellers that are also above the clearling price, or the reverse, buyers biding below the clearing price pairing with sellers who are also willing to sell below the clearin price. Elimination of both inframarginal and extramarginal trades that represend low value exchange pairings.
One thing I wonder about here is what information might be lost/masked and if the informational value might outweigh the reduction in suplus captured. But I’m also not sure that whatever information might be seen in the current structure is not also present in the end of day S&D schedules and so fully reflected in the price outcomes.
In practice it is not as bad as uniform volume throughout the day would be for two reasons:
Market-makers narrow spreads to prevent any low-value-exchange pairings that would be predictable price fluctuations. They do extract some profits in the process.
Volume is much higher near the open and close.
I would guess that any improvements of this scheme would manifest as tighter effective spreads, and a reduction in profits of HFT firms (which seem to provide less value to society than other financial firms).
I had prehaps a bit unjustly tossed the market maker role into that “not real bid/off” bucket. I also agree they do serve to limit the worst case matches. But such a role would simply be unnecessary so I still wonder about the cost in terms of the profits captured by the market makers. Is that a necessary cost in today’s world? Not sure.
And I do say that as someone who is fairly active in the markets and have taken advantage of thin markets in the off market hours sessions where speads can widen up a lot.
How efficient are equity markets? No, not in the EMH sense.
My take is that market efficiency viewed from economics/finance is about total surplus maximization—the area between the supply and demand curves. Clearly when S and D are order schedules and P and Q correspond to the S&D intersection one maximizes the area of the triangle defined in the graph.
But existing equity markets don’t work off an ordered schedule but largely match trades in a somewhat random order—people place orders (bids and offers) throughout the day and as they come in during market hours trades occur.
Given these are pure pecuniary markets the total surplus represents something of a total profit in the market for the day’s activities (clearly something different than the total profits to the actual share owners who sold so calling it profit might be a bit confusing). One might think markets should be structured to maximize that area but clearly that is not the case.
It would be a very unsual case for the daily order flow to perfectly match with the implied day demand and supply curves that would represent the bids and offers (lets call them the “real” bids and offers but I’m not entirely sure how to distinquish that from other bids and offers that will start evaporating as soon as they become the market bid or offer). So would a settlement structure line mutual funds produce a better outcome for equities?
Maybe. In other words, rather than putting a market order in and having it executed right then or putting a limit order in and if the market moves to that price it executes, all orders get put in the order book and then at market close the clearing price is determed and those trades that actually make sense occur. What is prevented is the case of either buyers above the clearlin price from getting paired with sellers that are also above the clearling price, or the reverse, buyers biding below the clearing price pairing with sellers who are also willing to sell below the clearin price. Elimination of both inframarginal and extramarginal trades that represend low value exchange pairings.
One thing I wonder about here is what information might be lost/masked and if the informational value might outweigh the reduction in suplus captured. But I’m also not sure that whatever information might be seen in the current structure is not also present in the end of day S&D schedules and so fully reflected in the price outcomes.
In practice it is not as bad as uniform volume throughout the day would be for two reasons:
Market-makers narrow spreads to prevent any low-value-exchange pairings that would be predictable price fluctuations. They do extract some profits in the process.
Volume is much higher near the open and close.
I would guess that any improvements of this scheme would manifest as tighter effective spreads, and a reduction in profits of HFT firms (which seem to provide less value to society than other financial firms).
I had prehaps a bit unjustly tossed the market maker role into that “not real bid/off” bucket. I also agree they do serve to limit the worst case matches. But such a role would simply be unnecessary so I still wonder about the cost in terms of the profits captured by the market makers. Is that a necessary cost in today’s world? Not sure.
And I do say that as someone who is fairly active in the markets and have taken advantage of thin markets in the off market hours sessions where speads can widen up a lot.