A New Measure of Market Inefficiency

Financial crises, such as the Great Financial Crisis of 2007–2009 and the COVID-19 Crisis of 2020–2021, lead to high volatility in financial markets and highlight the importance of the debate on the Efficient Markets Hypothesis, a corollary of which is that in an efficient market it should not be possible to systematically make excess returns. In this paper, we discuss a new empirical measure—Excess Trading Returns—that distinguishes between market and trading returns and that can be used to measure inefficiency. We define an Inefficiency Matrix that can provide a complete, empirical characterization of the inefficiencies inherent in a market. We illustrate its use in the context of empirical data from a pair of model markets, where information asymmetries can be clearly understood, and discuss the challenges of applying it to market data from commercial exchanges.

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FRACTAL MARKETS HYPOTHESIS AND THE GLOBAL FINANCIAL CRISIS: SCALING, INVESTMENT HORIZONS AND LIQUIDITY

Advances in Complex Systems ◽

10.1142/s0219525912500658 ◽

2012 ◽

Vol 15 (06) ◽

pp. 1250065 ◽

Cited By ~ 43

Author(s):

LADISLAV KRISTOUFEK

Keyword(s):

Financial Crisis ◽

Complex Systems ◽

Financial Markets ◽

Global Financial Crisis ◽

Efficient Markets ◽

Investment Horizon ◽

Heterogenous Agents ◽

Efficient Markets Hypothesis ◽

The Global Financial Crisis ◽

Underlying Processes

We investigate whether the fractal markets hypothesis and its focus on liquidity and investment horizons give reasonable predictions about the dynamics of the financial markets during turbulences such as the Global Financial Crisis of late 2000s. Compared to the mainstream efficient markets hypothesis, the fractal markets hypothesis considers the financial markets as complex systems consisting of many heterogenous agents, which are distinguishable mainly with respect to their investment horizon. In the paper, several novel measures of trading activity at different investment horizons are introduced through the scaling of variance of the underlying processes. On the three most liquid US indices — DJI, NASDAQ and S&P500 — we show that the predictions of the fractal markets hypothesis actually fit the observed behavior adequately.

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Subprime crisis and instability of global financial markets

Panoeconomicus ◽

10.2298/pan1002209r ◽

2010 ◽

Vol 57 (2) ◽

pp. 209-224

Author(s):

Ognjen Radonjic ◽

Miodrag Zec

Keyword(s):

Financial Crisis ◽

Financial Markets ◽

Global Financial Crisis ◽

Accurate Diagnosis ◽

Financial Instability ◽

Efficient Markets ◽

Subprime Crisis ◽

Efficient Markets Hypothesis ◽

Current Financial Crisis ◽

Illiquid Assets

In order to prescribe adequate remedies to treat the current financial crisis one has to understand what in the first place went wrong. An age ago, older generations wrote that disease could not be cured without an accurate diagnosis. In contrast to mainstream 'efficient markets hypothesis' we argue that Minsky's financial instability hypothesis gives numerous valuable insights into sources and possible consequences of current global financial crisis. Furthermore, two decades ago Hyman P. Minsky predicted possible developments and perils of ever growing process of securitization of illiquid assets.

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From Orthodoxy to Heterodoxy: Financial Crisis Literature Compared

Scientific Annals of Economics and Business ◽

10.1515/saeb-2016-0136 ◽

2016 ◽

Vol 63 (s1) ◽

pp. 71-87

Author(s):

Ignacio Martínez ◽

Gabriel Mursa

Keyword(s):

Financial Crisis ◽

Business Cycle ◽

Financial Markets ◽

Financial Crises ◽

Financial Instability ◽

Business Cycle Theory ◽

Economic Cycle ◽

Austrian Business Cycle Theory ◽

Economic Downturns ◽

Austrian Business Cycle

Abstract In this paper we’ll attempt to explain the connection between interventionism in financial markets, financial crises and economic downturns, as the main cause of the financial crisis mainstream models; As well as the connection between the theories of Austrian and Minsky’s economic cycle as branches of heterodox economic theory. In order to achieve this target, we’ll begin with a brief introduction of mainstream financial crises models in the orthodox economic literature, then we’ll examine the statements of the Austrian Business Cycle Theory and the Financial Instability Hypothesis, and evaluate whether a connection between the two. We conclude that Financial Instability Hypothesis can be studied as a particular case of the Austrian Business Cycle Theory.

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Model of Financial Crisis Contagion: A Survey-based Simulation by Means of the Modified Kaplan-Meier Survival Plots

Folia Oeconomica Stetinensia ◽

10.2478/foli-2013-0006 ◽

2013 ◽

Vol 13 (1) ◽

pp. 22-55 ◽

Cited By ~ 1

Author(s):

Paulina Roszkowska ◽

Łukasz Prorokowski

Keyword(s):

Financial Crisis ◽

Financial Markets ◽

Empirical Data ◽

International Investment ◽

Investment Strategies ◽

Structured Interviews ◽

Regulatory Frameworks ◽

Kaplan Meier ◽

International Linkages ◽

Simulation Results

Abstract The aim of this paper is to present a broad picture and novel aspects of the financial crisis contagion with respect to the stages of crisis contagion and its propagation factors. We employ a pioneering approach to a simulation of the financial crisis contagion by embarking on a qualitative query rather than on empirical data (i.e. by adopting an international investor’s perspective by conducting the qualitative query backed by semi-structured interviews with financial markets’ participants). Building on modified Kaplan-Meier Survival Plots, we suggest a model for the financial crisis contagion based on international linkages between markets, with particular attention paid to spot vulnerabilities in regulatory frameworks that allowed for the crisis to spread. Simulation results showed that there were several phases of crisis contagion in Europe, and different countries (regions) were contained via different paths, propagated by different factors with not equal intensity. The diversity of European countries’ susceptibility is evident not only when comparing advanced markets to the emerging ones, but also within these groups. Hereto, both international investment practitioners, as well as pan European market authorities should analyse with scrutiny the links emerging from the simulation, so that to develop sound and efficient investment strategies or impose tailor-made regulations for financial markets.

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Testing the Empirical Validity of the Adaptive Markets Hypothesis

Review of Economic Analysis ◽

10.15353/rea.v9i2.1440 ◽

2017 ◽

Vol 9 (2) ◽

pp. 169-184

Author(s):

Hany Fahmy

Keyword(s):

Financial Markets ◽

Behavioral Finance ◽

Asset Allocation ◽

Smooth Transition ◽

Efficient Markets ◽

Irrational Behavior ◽

Smooth Transition Regression ◽

Efficient Markets Hypothesis ◽

Smooth Transition Regression Model ◽

Over Time

The issue of market e¢ ciency attracted the attention of academicians since the existence of financial markets. Over time, two schools of thoughts were established: the efficient markets school and the behavioral finance school. Proponents of the former believed in the Efficient Markets Hypothesis whereas the latter brought evidence from behavioral finance and psychology to demonstrate that financial markets are inefficient and this inefficiency is attributed to the irrational behavior of investors in making financial choices regarding asset allocation and portfolio construction. Recently, an adaptive reconciliation was suggested, which posits that investors'adaptability is what brings back inefficient markets to efficiency. The purpose of this paper is to test empirically the validity of the Adaptive Markets Hypothesis via a smooth transition regression model with exogenous threshold variable. The results support the reconciliation and show that markets are indeed efficient sometimes and inefficient most of the time.

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International diversification during financial crises

Managerial Finance ◽

10.1108/mf-11-2017-0477 ◽

2018 ◽

Vol 44 (12) ◽

pp. 1434-1445

Author(s):

Chu-Sheng Tai

Keyword(s):

Financial Crisis ◽

Stock Market ◽

Financial Markets ◽

Financial Crises ◽

International Diversification ◽

Subprime Crisis ◽

Content Type ◽

Empirical Results ◽

The Impact ◽

Dot Com

Purpose The purpose of this paper is to provide empirical evidence on how 1999–2001 dot-com crisis and 2007–2009 subprime crisis affect the gains from international diversification from the perspective of US investors. Design/methodology/approach A conditional international CAPM with asymmetric multivariate GARCH-M specification is used to estimate international diversification gains. Findings The authors find that over the entire sample period, the average gains from international diversification is statistically significant and about 1.253 percent per year. During the subprime crisis period, the average gains decreases to about 0.567 percent per year, but it increases to 2.829 percent per year during the dot-com crisis. Research limitations/implications These research findings although confirm the conjectures that international financial turmoil tends to increase the co-movements among global financial markets, are in contrast to the conjectures that international diversification does not work during the financial crisis as evidence from the dot-com crisis. Therefore, future research on international diversification should not just focus on the correlation among international financial markets and should adopt a fully parameterized asset pricing model to study this research topic. Practical implications Given the empirical results found in this paper that international diversification gains may be decreasing or increasing during the financial crisis, as long as investors are not able to predict international financial crises, it is the average gains from international diversification over the longer periods that should encourage investors to diversify, regardless of potentially lower benefits over the shorter periods of time. Originality/value The major value of this paper is that although the increase in the conditional correlation during the financial turmoil is consistent with previous studies, the empirical results clearly show that the impact of a financial crisis on the gains from international diversification cannot be solely determined by the correlation between domestic and world stock market returns since the gains also depend on the unsystematic risk from the domestic stock market. Consequently, it is premature for previous studies to conclude that the gain from international diversification is diminishing due to an increasing correlation among international stock markets during the financial crisis.

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Tests of the Efficient Markets Hypothesis

Austrian Journal of Statistics ◽

10.17713/ajs.v26i1.541 ◽

2016 ◽

Vol 26 (1) ◽

Author(s):

Erhard Reschenhofer ◽

Michael A. Hauser

Keyword(s):

Time Series ◽

Financial Markets ◽

Statistical Methods ◽

Stock Return ◽

Efficient Markets ◽

Efficient Markets Hypothesis

This paper surveys various statistical methods that have been proposed for the examination of the efficiency of financial markets and proposes a novel procedure for testing the predictability of a time series. For illustration, this procedure is applied to Austrian stock return series.

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International Monetary Law: Issues for the New Millenium. Edited by Mario Giovanoli. [Oxford: Oxford University Press. 2000. li, 515 and (Index) 22 pp. Hardback. £125 net. ISBN 0–19–829923–0.]

The Cambridge Law Journal ◽

10.1017/s0008197302291783 ◽

2002 ◽

Vol 61 (3) ◽

pp. 715-738

Author(s):

Kern Alexander

Keyword(s):

Financial Crisis ◽

Financial Markets ◽

Interest Rates ◽

Financial Crises ◽

Current System ◽

Banking Crisis ◽

Oxford University ◽

Speculative Attack ◽

International Financial Architecture ◽

The Government

The financial crises that spread through East Asia, Russia and Latin America in the late 1990s have led to renewed calls for reform of the “international financial architecture” that would involve legal and institutional changes for the regulation of international financial markets. Since the end of the Bretton Woods system in the early 1970s, there have been over 100 financial crises while 132 of the 184 members of the International Monetary Fund have suffered varying degrees of banking fragility and distress. Although the term “banking crisis” and “financial crisis” are often used interchangeably, the IMF defines a financial crisis as a currency crisis, which is a speculative attack on the currency either causing a devaluation or forcing the authorities to spend large amounts of foreign exchange reserves to purchase its currency or to raise interest rates sharply. A banking crisis refers to actual or potential bank runs or failures, which induce banks to suspend the internal convertibility of their liabilities or to compel the government to intervene. Financial and banking crises often have systemic consequences, impairing markets’ ability to function effectively and may have major adverse effects on the economy. Many experts agree that adequate regulation at the domestic and international levels has not accompanied the progressive liberalisation of financial markets and, in particular, of short-term capital flows. It is a serious defect with the current system that the development of international monetary and financial law—at least in the areas of regulation and supervision—has only occurred haphazardly and principally as a result of a series of financial crises that began in the mid 1970s. Indeed, this book is a welcomed contribution to understanding many of the complex issues that arise in international monetary and financial law.

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ICT and the Efficient Markets Hypothesis

Information Communication Technologies ◽

10.4018/978-1-59904-949-6.ch255 ◽

2008 ◽

pp. 3623-3633

Author(s):

Andrea J.A. Roofe

Keyword(s):

Qualitative Methods ◽

Financial Markets ◽

Capital Market ◽

Technological Development ◽

Efficient Markets ◽

Preliminary Attempt ◽

Lack Of Information ◽

Efficient Markets Hypothesis ◽

The Relationship ◽

The Capital Market

This article represents a preliminary attempt to indentify the variables influencing the relationship between technological development and efficiency in the financial markets of a Caribbean economy. The analysis uses qualitative methods only. From the late 1980s, Kitchen (1988) observed, “… the major inefficiency in the capital market is the lack of information…” (p. 48).

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