Reconsidering Market Efficiency: A Tale of Two Exchanges

24 Pages Posted: 8 Dec 2011 Last revised: 16 Dec 2011

See all articles by Jennifer W. Kuan

Jennifer W. Kuan

Tulane University - A.B. Freeman School of Business

Stephen F. Diamond

Santa Clara University - School of Law

Date Written: November 19, 2009

Abstract

The efficient markets hypothesis argues that the price of a financial asset reflects available information about that asset. Competing theories argue that other factors, including investor behavior, can cause asset prices to diverge from the efficient price leading to “bubbles.” We argue that the governance of market institutions plays a profound role in achieving market efficiency. In particular, we note that until recently, both the New York Stock Exchange and the NASDAQ were non-profit firms. We then identify an objective function for each of these firms and argue that the NYSE had an incentive to produce an informationally efficient marketplace for equities whereas the NASDAQ benefited from inefficiency. We test our hypothesis using a natural experiment, the IPO of the NYSE in 2006, and find that bid-ask spreads on the NYSE were consistently lower than the NASDAQ but then converged after demutualization. We believe that our approach helps resolve an apparent tension between competing theories of market behavior and contributes an analytical framework from which to consider regulatory changes.

Suggested Citation

Kuan, Jennifer W. and Diamond, Stephen F., Reconsidering Market Efficiency: A Tale of Two Exchanges (November 19, 2009). Available at SSRN: https://ssrn.com/abstract=1528563 or http://dx.doi.org/10.2139/ssrn.1528563

Jennifer W. Kuan

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

Stephen F. Diamond (Contact Author)

Santa Clara University - School of Law ( email )

500 El Camino Real
Santa Clara, CA 95053
United States

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