Arbitrage Risk and Market Efficiency – Applications to Securities Class Actions

30 Pages Posted: 30 Jan 2015 Last revised: 13 Jun 2017

Date Written: 2015


Measuring the efficiency of the market for a stock is important for a number of reasons, but such measurements have been widely utilized in securities class action litigation, particularly to justify certification of cases as appropriate for class action treatment. We provide a general methodology to measure the arbitrage risk, which is a negative proxy for the market efficiency, of a stock for any relevant period. We apply this methodology to calculate the arbitrage risk of each U.S. exchange-listed common stock for every calendar year from 1988 to 2010. We find that market efficiency is significantly affected by turnover (negatively), the number of market makers for Nasdaq stocks (negatively), and serial correlation in the Capital Asset Pricing Model of the stock (positively). These findings seem inconsistent with “conventional wisdom” and with the understanding that courts use in applying notions of market efficiency to class certification decisions, but we show that our findings are consistent with economic logic. The relations between market efficiency and market capitalization (positive), bid-ask spread (negative) and institutional ownership (positive) are consistent with conventional wisdom. The impact on market efficiency of the number of securities analysts following a stock and the public float ratio of a stock are of ambiguous significance.

Suggested Citation

Bhattacharya, Rajeev and O'Brien, Stephen Jerome, Arbitrage Risk and Market Efficiency – Applications to Securities Class Actions (2015). Santa Clara Law Review, 2015; profiled on the website of Stanford University, Available at SSRN:

Rajeev Bhattacharya (Contact Author)

Washington Finance and Economics ( email )

United States


Stephen Jerome O'Brien

Dentons LLP ( email )

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