Monday, October 17, 2011

Efficient Equilibrium, EMH and A Rich World of Internal Dynamics (Physics of Finance)

What moves the markets? Part I (& II)

It's a key assertion of the Efficient Markets Hypothesis that markets move because of news and information. When new information becomes available, investors quickly respond by buying and selling to register their views on the implications of that information. This is obviously partially true -- new information, or what seems like information, does impact markets.

Yesterday, for example, US Treasury Secretary Timothy Geithner said publicly that, despite the ominous economic and financial climate, there is “absolutely” no chance that another United States financial institution will fail. (At least that's what the New York Times says he said; they don't give a link to the speech.) That was around 10 a.m. Pretty much immediately (see the figure below) the value of Morgan Stanley stock jumped upwards by about 4% as, presumably, investors piled into this stock, now believing that the government would step in the prevent any possible Morgan Stanley collapse in the near future. A clear case of information driving the market:

Of course, this just one example and one can find further examples, hundreds every day. Information moves markets. Academics in finance have made careers by documenting this fact in so-called "event studies" -- looking at the consequences for stock prices of mergers, for example.



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