On the (Significant) Possibility of Informationally-Efficient Markets
8 Pages Posted: 23 Sep 2019 Last revised: 4 Nov 2019
Date Written: June 30, 2019
Financial markets with optimistic/overconfident investors will be efficient absent substantial short-sale constraints or seller lockups, because optimistic/overconfident investors do not require - as do the rational speculators in the Grossman and Stiglitz's (1980) "impossibility" result - equilibrium mispricing to draw them into speculation. Instead, they overestimate the profitability of their speculation, impounding information quickly into prices as a result. However, prices can deviate from efficient-markets values in the presence of substantial short-sale constraints or buyer or seller lockups. These predictions are consistent with the superiority of passive investment strategies (because markets are efficient and active investment is costly) and the documented effect of certain limits to arbitrage in facilitating mispricing.
Keywords: optimism, overconfidence, market efficiency, limits to arbitrage, passive investing, active management
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