Market Efficiency - A Structural Study

74 Pages Posted: 4 Jan 2021 Last revised: 16 Feb 2021

Date Written: February 11, 2021


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 (six- for non-Nasdaq stocks) structural model with market efficiency as a function of exogenous factors (transaction costs & constraints, short sales costs & 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 structural system 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 that the impact on market efficiency is ranked as follows: transaction costs & constraints, short sales costs & constraints, and dispersion in investor valuations, that the Fama-French Factors, individually and together, are substantially important in affecting these relationships in sign and significance, and that market efficiency is significantly but differently associated with endogenous market activities.

Detailed Regression Results:

Keywords: Event Studies; Earnings Announcements; Key Developments; Arbitrage Risk; Idiosyncratic; Volume; Short Interest; Analysts; Market Makers; Institutional Holdings; Shares Outstanding; Transaction Costs; Short Sales Costs; Bid-Ask; Dispersion; Endogeneity; Simultaneity; Unavailable; Proxy; Instruments

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

Suggested Citation

Bhattacharya, Rajeev, Market Efficiency - A Structural Study (February 11, 2021). Available at SSRN: or

Rajeev Bhattacharya (Contact Author)

Washington Finance and Economics ( email )

United States


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