Convergence to Market Efficiency of Top Gainers
Date Issued
2008
Date
2008
Author(s)
Hsu, Ming-Wei
Abstract
Market efficiency has been a debated topic in the field of finance for a long time, as a great amount of research on the topic of market anomalies and behavioral finance linked to psychology has been revealed. These conflicting topics can be reconciled by the concept of “aggregation.” All kinds of investors gathering together will push the market toward efficiency to the extent that no one could earn an abnormal profit by any trading strategies continuously. It is intuitive that efficiency cannot happen instantaneously in the real world. The central purpose of our study is to investigate the convergence process toward efficiency of daily top gainers in the stock market. First of all, we examine the relation between returns and contemporaneous as well as lagged order imbalances by a multi-regression model. The empirical result shows that the contemporaneous imbalances have a significantly positive impact on returns, and the lagged-one imbalances also have a positive impact on returns disregarding the contemporaneous imbalances. But once we condition on the contemporaneous imbalances, the impact of the lagged-one imbalances on returns generally turns to be negative. Besides, we observe a positive relation between contemporaneous imbalances and returns by the use of a GARCH(1,1) model. The convergence process toward efficiency, whether in the multi-regression model or the GARCH(1,1) model, is observable. That is, the explanatory ability of order imbalances decreases as the time interval increases. In addition, we examine the relation between volatility and order imbalances by a GARCH(1,1) model. The relation is not strong enough, suggesting that market makers do have a capable ability to control volatility of price movements. Moreover, we perform a simple regression model to investigate whether there is any relation between market capitalization and order imbalances. It is significant only in the imbalance variables obtained from the OLS regression model, showing that the effect comes from volatility but not small firm effect itself. Finally, we try to build a trading strategy based on the indicator of order imbalances. This trading strategy earns a positive profit but still cannot beat the original open-to-close return of top gainers.
Subjects
order imbalance
market efficiency
SDGs
Type
thesis
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