Published February 2008
| public
Journal Article
Liquidity and market efficiency
Abstract
Short-horizon return predictability from order flows is an inverse indicator of market efficiency. We find that such predictability is diminished when bid-ask spreads are narrower, and has declined over time with the minimum tick size. Variance ratio tests suggest that prices were closer to random walk benchmarks in the more liquid decimal regime than in other ones. These findings indicate that liquidity stimulates arbitrage activity, which, in turn, enhances market efficiency. Further, as the tick size decreased, open-close/close-open return variance ratios increased, while return autocorrelations decreased. This suggests an increased incorporation of private information into prices during more liquid regimes.
Additional Information
© 2007 Elsevier B.V. Received 23 May 2006, Revised 28 February 2007, Accepted 22 March 2007, Available online 9 October 2007. We are grateful to two anonymous referees and Bill Schwert (the editor) for their constructive insights and encouragement. We also thank Doron Avramov, Suman Banerjee, Ekkehart Boehmer, Michael Brandt, Guy Charest, Nai-fu Chen, Gustavo Grullon, Soeren Hvidkjaer, Vojislav Maksimovic, Barbara Ostdiek, Lemma Senbet, Haluk Unal, James Weston, and seminar participants at Faculdade de Economia, Universidade do Porto, ISCTE, Rice University, Tulane University, University of California at Irvine, University of Georgia, University of Maryland, University of Montreal, University of Quebec at Montreal, Universidad de Santiago de Chile, the Norwegian School of Economics, and the conference on Microstructure of International Financial Markets at the Indian School of Business, for valuable comments. We also thank Morgan Stanley for the market microstructure grant that funded this project.Additional details
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- CaltechAUTHORS:20190430-103517828
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