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The Efficient Markets Hypothesis Does Not Hold When Securities Valuation Is Computationally Hard

48 Pages Posted: 2 Mar 2017  

Shireen Tang

The University of Melbourne - Department of Finance

Shijie Huang

The University of Melbourne - Department of Finance

Elizabeth Bowman

The University of Melbourne - Department of Finance

Nitin Yadav

The University of Melbourne - Department of Finance

Carsten Murawski

The University of Melbourne - Department of Finance; Financial Research Network (FIRN)

Peter Bossaerts

Brain, Mind and Markets Laboratory

Date Written: February 28, 2017

Abstract

We study the Efficient Markets Hypothesis (EMH) in a setting where information heterogeneity emerges because securities valuation requires solving an NP-hard problem. We demonstrate experimentally that the quality of prices deteriorates substantially as computational complexity increases. Participants whose valuations are closer to true values earn more from trading. Participants improved their individual valuations by learning from market data, and their individual valuations on average were better than those reflected in market prices. These results are in sharp contrast with findings in experiments where correct valuation requires averaging of private information. They suggest that EMH only holds in very specific circumstances.

Keywords: Efficient Markets Hypothesis, Computational Complexity, Financial Markets, Grossman-Stiglitz Paradox, Hirshleifer Effect, Intellectual Discovery, Patents, Prediction Markets

JEL Classification: G14, C92, D82

Suggested Citation

Tang, Shireen and Huang, Shijie and Bowman, Elizabeth and Yadav, Nitin and Murawski, Carsten and Bossaerts, Peter, The Efficient Markets Hypothesis Does Not Hold When Securities Valuation Is Computationally Hard (February 28, 2017). Available at SSRN: https://ssrn.com/abstract=2925071 or http://dx.doi.org/10.2139/ssrn.2925071

Shireen Tang

The University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Parkville, Victoria 3010 3010
Australia

Shijie Huang

The University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Parkville, Victoria 3010 3010
Australia

Elizabeth Bowman

The University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Parkville, Victoria 3010 3010
Australia

Nitin Yadav

The University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Parkville, Victoria 3010 3010
Australia

Carsten Murawski

The University of Melbourne - Department of Finance ( email )

Brain, Mind & Markets Lab
Parkville, Victoria 3010
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Peter L. Bossaerts (Contact Author)

Brain, Mind and Markets Laboratory ( email )

Faculty of Economics and Commerce
Department of Finance
Carlton, Victoria 3010
Australia

HOME PAGE: http://bmmlab.org

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