Commonality in Market Efficiency
Market efficiency remains central to the study of financial markets. We propose that the degree of efficiency not only varies over time, but also across stocks, and examine whether there are common components in the time-varying price efficiency of individual stocks. Using short-horizon return predictability from order flows as an inverse indicator of efficiency, we find evidence of significant commonality in efficiency. The degree of commonality in efficiency varies through time with measures of aggregate funding liquidity, frictions that impede arbitrage, and microstructural aspects that affect market making efficacy. Our results indicate that stock price efficiency has a component that is prone to systematic improvements and deterioration. They also imply that policies that impact funding liquidity can systematically affect stock market efficiency.
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