The case for market inefficiency: Investment style and market pricing
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Ron Bird* is an Emeritus professor from the Australian National University (ANU) Canberra and currently is an associate professor at University of Technology Sydney (UTS). His research interests lie in the areas of market efficiency and market manipulation.
Xue-Zhong (Tony) He received his PhD from UTS, where he is currently a senior lecturer. His research is focused on non-linear economic dynamics and financial market modelling with heterogeneous interacting agents.
Satish Thosar received his PhD in Finance from Indiana University, USA, and is currently an associate professor at UTS. His main research interests lie in the areas of behavioural finance and IPO aftermarket dynamics.
Paul Woolley is Chairman of GMO (Europe) and an honorary fellow at the University of York. His current research is focused on the economic implications of different investments styles. *School of Finance and Economics, University of Technology Sydney, PO Box 123, Broadway NSW 2007 Australia Tel: ⫹612 9514 7716; Fax: ⫹612 9514 7711; e-mail: [email protected]
Abstract The level of informational efficiency of security markets has been a contentious issue among the academic and broader community over the last 35 years. This study highlights the growth in popularity in investment styles over this period, where investment decisions are made with only limited reference to available information and no concern with fair value (eg momentum investors and index investors). This paper models the market behaviour of fundamental, momentum and index investors and then simulates the behaviour of security prices in a market composed of investors following these three styles. Evidence is found to suggest that compositions of investment styles that are fairly typical of the mix of investors in current-day markets will lead to anomalous price behaviour similar to that found by other writers: an underreaction to new information which often gives rise to a subsequent overreaction. Keywords: investment styles, market efficiency, Monte Carlo simulation
Introduction One of the important conditions required to ensure efficiency in market pricing is that investors actively compete in the
䉷 Henry Stewart Publications 1479-179X (2005)
market based upon perceived mispricing derived from an analysis of available information. In such a world, it is assumed that prices are soon driven to
Vol. 5, 6, 365–388
Journal of Asset Management
365
Bird, He, Thosar and Woolley
their fair value or, at least, to a level where investors, based upon the available information set, cannot consistently identify stocks whose prices are at variance with fair value. The focus in this paper is on investigating the potential for efficiency within markets where many market participants pursue investment styles that pay little or no attention to either fair pricing or available information. Index and momentum investing represent two instances of such investment styles that have become more popular in recent years. Index investing actually stems from a belief that markets are effici
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