A Market Microstructure View of the Informational Efficiency of Security Prices

Do equity prices efficiently reflect fundamental information as the Efficient Markets Hypothesis suggests? The author challenges a widely held acceptance by financial academicians of the EMH. In a frictionless environment, information acquisition and trading would be costless, transaction prices would reflect information perfectly, prices would follow random walks, and the EMH would be validated. But markets are not frictionless. The assumption is commonly invoked in academic research that informed investors have homogeneous expectations. But, given the enormity and complexity of information sets, investor expectations differ. Taking an intraday, microstructure focus, the author explains that price discovery in a non-frictionless, divergent expectations environment is a protracted, dynamic process that accentuates intra-day price volatility and introduces return autocorrelations. This counters the EMH. He stresses the importance of instituting a market structure that further enhances the operational and therefore informational efficiency of a security market