In this paper it will be examined if markets are macro-inefficient and micro-efficient at the same time. In order to give a thorough understanding about efficient markets, there will be an overview in the following chapter. After that, the research question is discussed and managerial implication are given.
At a glance
- Applies Samuelson’s dictum to individual securities and aggregate stock markets
- Uses the 1990s technology bubble to illustrate market feedback
- Examines short-selling constraints and noise-trader risk as limits to arbitrage
- 18 sources in the bibliography
Table of Contents
1 Introduction
2 Efficiency of markets
3 Discussion of the research question
4 Implications for managerial decisions
5 Conclusion
Objectives and Topics
This essay critically examines whether markets can be efficient at the level of individual securities while inefficient at the aggregate level, and considers the implications for managerial decisions. It draws on market-efficiency and behavioral-finance literature to explore pricing, investor behavior and corporate financial strategy.
- Informational efficiency and its weak, semi-strong and strong forms
- Samuelson’s distinction between micro-efficiency and macro-inefficiency
- Informed investors, noise traders and limits to arbitrage
- Behavioral biases and market bubbles
- Investor relations and strategic corporate finance decisions
Excerpt from the Book
Discussion of the research question
After explaining the efficiency of markets, the next step is now to differentiate between the micro and macro levels of markets. The micro level refers to the individual securities traded in a market. There is evidence that particular stock prices are interrelated with efficient market theory (Shiller 2003). Micro efficiency evolves if the few investors who detect small anomalies in stock prices take profit by conducting arbitrage trades. That leads to the extinguishment of the present inefficiencies and creates micro efficiency, as Samuelson (1998) stated in his famous dictum concerning micro-efficiency and macro-inefficiency (Jung/Shiller 2002). “Over the interval of U. S. history since 1926, individual-firm dividend-price ratios have had some significant predictive power for subsequent growth rates in real dividends: this is evidence of micro-efficiency. “(Ibid.)
To examine the presence of micro-efficiency, a closer look to the pricing on a company level is necessary. Basically, a firm’s fundamentals, like its book-to-market value, explains a large part of its future earnings. Thus, the future dividend situation can be better predicted for a single company than for an aggregate market. As the dividend projection is a good indicator for future price movements and - by using a discounted cash flow approach – also an important variable for company valuation, one can calculate a fair value price by incorporating this data (Shiller 2003). The group of traders who conduct their buying and selling decisions on such a rational and fact-based way is called “informed investors”, they work very effective as they are responsible for the long-term share price development. They typically have different opinions about the correct intrinsic value, but as a group they can drive the actual share price towards a realistic range which represents the approximate discounted value of the predicted future dividend cash flows. This range is extended to both sides by around 10% as insecurity about the real intrinsic value and trading costs are keeping informed investors from reacting to fast (Koller et al. 2015).
The opposing group is called “noise traders”. They are typically not interested in fundamentals as they focus purely on recent news and certain events which could lead to short-term share price movements they want to capture. One example of noise trading is a momentum strategy. In this tactical type of investing, price trends are detected and followed assuming that the movement will continue. By doing this, trends are accelerated until the mentioned range of the intrinsic value plus 10% is reached and informed investors are slowing down and eventually stopping the price movement by taking opposite positions representing their fundamental view (Ibid.). Knowing this behavior of those two groups, one can conclude that the rational behavior of the informed investors prevails in defining a correct market price for individual securities, leading in fact to micro-efficient markets.
Chapter Summaries
1 Introduction: Introduces the question of whether macro-inefficiency and micro-efficiency can coexist and outlines the discussion of managerial implications.
2 Efficiency of markets: Explains informational market efficiency and distinguishes weak, semi-strong and strong forms of the efficient market hypothesis.
3 Discussion of the research question: Examines pricing at the individual-security and aggregate-market levels, including informed trading, noise trading, arbitrage constraints and behavioral explanations of bubbles.
4 Implications for managerial decisions: Considers investor relations and strategic financial decisions, including share issuance, buybacks, divestments and acquisitions.
5 Conclusion: Summarizes the argument about market efficiency at different levels and considers the risks and opportunities for investors and corporate decision-makers.
Keywords
market efficiency, micro-efficiency, macro-inefficiency, efficient market hypothesis, Samuelson’s dictum, behavioral finance, informed investors, noise traders, arbitrage, market bubbles, intrinsic value, investor relations, corporate finance
Frequently Asked Questions
What is this work about?
It evaluates whether individual securities can be priced efficiently while the stock market as a whole deviates from fundamental value.
What are the central topics?
The essay covers informational efficiency, investor behavior, arbitrage, behavioral biases, market bubbles and corporate financial decisions.
What is the main research question?
It asks whether markets can be simultaneously macro-inefficient and micro-efficient, and what that means for managers.
What research method does the author use?
The author develops a critical discussion based on published literature and examples rather than presenting an original empirical study.
What does the main discussion examine?
It compares the pricing of individual securities with aggregate market pricing and considers how informed investors, noise traders and constraints on arbitrage affect each level.
Which keywords characterize the work?
Key terms include market efficiency, Samuelson’s dictum, behavioral finance, noise trading, arbitrage, intrinsic value and corporate finance.
How does the essay distinguish the forms of market efficiency?
It describes weak efficiency in relation to past prices, semi-strong efficiency in relation to public information, and strong efficiency as also incorporating material non-public information.
What role does the technology bubble play in the discussion?
The essay uses the 1990s technology bubble to illustrate feedback between price increases, investor attention and expectations.
Which managerial decisions are considered?
The discussion addresses investor communications as well as share issuance, repurchases, divestments and acquisitions when market prices diverge from intrinsic values.
- Citation du texte
- Arno Hetzel (Auteur), 2018, Macro-inefficient but micro-efficient markets. Managerial implications, Munich, GRIN Verlag, https://www.grin.com/document/449817
