The Evolution of Market Efficiency Over the Past Century

Contrary to the prevailing view, equity markets have not followed a consistent trend toward increasing efficiency over time. Instead, stock prices are more efficient during the early and late decades of the past century, but less efficient in the middle decades. Our findings are robust to controlling for firm-specific attributes and stock market conditions, as well as across different industries. This U-shaped trend in efficiency is linked to the capacity of arbitrageurs to update prices, as proxied by the average wage and education levels in the finance industry, which are in turn driven by changes in financial deregulation over time. This analysis establishes that the flow of skilled human capital to financial markets is an important determinant of market efficiency, and thereby uncovers an important social role for quality human capital that benefits resource allocation in financial markets and the economy.