Lesson 2 of 7 · 14 min
What makes a market more or less efficient
A market is more efficient the more participants and analysts follow it, the better and fairer its information flow, the fewer the limits on trading (including short selling), and its efficiency is always judged net of transaction and information-acquisition costs.
In short
- Efficiency is a continuum that varies over time, across countries and by type of market.
- More market participants and more analyst coverage raise efficiency; restrictions such as limits on foreign investors reduce it.
- Information availability and financial disclosure raise efficiency; rules on fair disclosure and insider trading promote fairness and participation.
- Arbitrage pushes prices together; anything that limits it (slow execution, high costs, opaque prices, short-selling restrictions) impedes efficiency.
- Prices are efficient within the bounds of arbitrage: a gap smaller than the transaction costs of the cheapest trader is not an inefficiency.
- Modern view: a market is inefficient only if active investors earn superior risk-adjusted returns after information-acquisition and transaction costs; a gross return to research is expected even in an efficient market.
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