Does Liquidity Affect Securities Market Efficiency? – (PDF – Listed at CFM) – [previous title: Does Noise Trading Affect Securities Market Efficiency?] – by Paul Tetlock – 2006-11-XX
The basic idea of the paper is simple. I measure liquidity and expected returns for various securities, and show that the two are linked. In an efficient market, the benchmark is that all securities should have zero expected returns. I find that the illiquid securities markets have (close to) zero expected returns, implying that these markets are efficient. But the liquid securities show certain mispricing patterns. The nature of these patterns suggests that individuals’- probability misperceptions are the cause of the mispricing in liquid securities.
Note: the zero expected returns benchmark is a simplification. It’-s based on the assumption that the equilibrium price of risk is negligible, which is a good approximation for most securities on TradeSports –-e.g., sports contracts, and most of the short-term financial contracts. Obviously, this assumption would fail in conventional financial markets, where risk premiums may be large.
Previous Blog Posts:
– Paul Tetlock on the inner working of TradeSports-InTrade
– No change: Mispricing is greater in illiquid markets + Justin Wolfers’-s comment
– Does Liquidity Affect Securities Market Efficiency?
– Short Odds for Ignorance
– Gambling and a New Approach to Regulating Information Markets
– TradeSports forum thread
Yeah, it was the Paul Tetlock festival, today.