Market Efficiency - A Structural Study

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See all articles by Rajeev R. Bhattacharya

Rajeev R. Bhattacharya

Washington Finance and Economics; Johns Hopkins University

Date Written: October 18, 2020


I use eight different metrics as separate objective and systematic measures of the efficiency of the market for a stock. I develop a seven-equation structural model with market efficiency as a function of exogenous factors (transaction costs and constraints, short sales costs and constraints, and dispersion in investor valuations) and endogenous market activities (trading volume, short interest, number of analysts, institutional holdings, shares outstanding, and number of market makers (for Nasdaq stocks)), and each endogenous market activity as a function of the exogenous factors and all other endogenous market activities. I propose a theoretical model that shows that higher trading volume (or another similar market activity) is caused by lower transaction costs, lower short sales costs, and/or higher dispersion of investor valuations, and therefore, that the impact on market efficiency of transaction costs or short sales costs is an empirical question. I apply Three Stage Least Squares and Errors in Variables to estimate the seven-equation structural model and test the corresponding hypotheses, using combinations of panel-based instrumentation strategies for endogenous and inaccurately measured variables. Analyzing Nasdaq and non-Nasdaq stocks separately, I find, contrary to much previous theoretical and empirical work, that market efficiency is not significantly negatively impacted by exogenous factors and that endogenous market activities are not significantly and positively associated with market efficiency.

Keywords: Market Efficiency, Event Studies, Earnings Announcements, Key Developments, Arbitrage Risk, Idiosyncratic Risk, Trading Volume, Short Interest, Analysts, Market Makers, Institutional Holdings, Shares Outstanding, Transaction Costs and Constraints, Short Sales Costs and Constraints, Bid-Ask Spread, Dispersion, Valuation, Structural System, One-Tailed and Two-Tailed Hypotheses, Endogeneity, Simultaneity, Missing/Unavailable Data, Proxy Variables, Instrumental Variables

JEL Classification Codes: G14; G12; C58; C33; C36.

Keywords: Event Studies, Earnings, Key Developments, Arbitrage Risk, Idiosyncratic Risk, Volume, Short Interest, Analysts, Market Makers, Institutional Holdings, Shares Outstanding, Transaction Costs, Short Sales Costs, Bid-Ask Spread, Dispersion, Structural System, Endogeneity, Simultaneity, Instrument

JEL Classification: G14, G12, C58, C33, C36

Suggested Citation

Bhattacharya, Rajeev, Market Efficiency - A Structural Study (October 18, 2020). Available at SSRN:

Rajeev Bhattacharya (Contact Author)

Washington Finance and Economics ( email )

United States


Johns Hopkins University

1717 Massachusetts Avenue, NW
Washington, DC 20036
United States

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