On the Efficiency and Equity of Betting Markets

Confident in belief that vital resource allocation decisions depend on well functioning capital markets, economists over last two decades have spent a good deal of their time, and not a little of computer's, studying behaviour of stock market prices. Their main aim has been to discover extent to which capital markets, and in particular markets in equity shares, are Perhaps surprisingly to layman, their answer has usually been very efficient, and despite amount of effort devoted to attempts at refutation, Fama was able to conclude that the evidence in support of market's model is extensive and (somewhat uniquely in economics) contradictory evidence is sparse (Fama, 1970, p. 416). The definition of efficiency being used is not, however, usual one and reflects fact that stock markets are being examined as markets, not as service industries. A stock market is efficient if its prices always information. Almost all empirical work proceeds on assumption that conditions of market equilibrium can be stated in terms of expected returns, and it is becoming conventional to talk of three subsets of in relation to determination of equilibrium expected returns: historical prices (and returns), other publicly available (e.g. announcements of earnings, issues, etc.) and inside (i.e. to which particular groups or individuals have monopolistic access at relevant points of time). Defining information as each of these in turn pro-duces weak, semi-strong and strong tests of efficiency. If prices always fully reflect historical prices in sense that price changes approximate a random walk, market is said to be weakly efficient. The bulk of empirical work has been done in this area. While some drift is usually found and some filters (mechanical trading rules) have been discovered that produce profits in excess of a naive buy-and-hold policy, it is generally agreed that these have little practical significance given transaction costs (brokerage) needed to implement them. If prices fully reflect public announcements as soon as they are made, market is said to be semi-strongly efficient. Only a small, though rapidly growing, volume of work has been done on this, particularly on dividend announcements and bonus issues.