On the Impossibility of Informationally Efficient Markets
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What they found
This theory paper shows a logical hole in perfect efficiency: if prices already reflected all information, nobody would pay to gather information, so nobody would trade on it, so prices could not reflect it. In equilibrium, prices must be noisy enough that informed traders earn just enough to cover their research costs. The amount of inefficiency in a market is therefore tied to how expensive information is and how much noise trading exists.
What you can use
- Markets can only be as efficient as the cost of information allows; edges exist, but they are competed down to roughly the cost of finding them.
- Your expected profit from research is bounded by what other researchers are paying to do the same work.
- Noise traders (people trading for reasons other than information) are what make informed trading profitable at all.
Caveats
Pure theory with a stylized model; it does not measure how inefficient any real market is. Heavy on math.
Tags: efficiency, theory, information
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.