Markets Take Time to be Efficient

Martin Pretty

Markets are supposed to price in new information efficiently. But for the investor who has done their homework in advance, time is on their side. Stock prices can react gradually rather than instantly to new information. Information can sit in the public domain but not be widely known and understood.

While information may exist in the public domain, it may not have been distributed widely; or it may be widely distributed without a broad base of investors having the additional knowledge to understand the materiality of one piece of information among many.

The smaller a company is, the less likely it is able to broadly disseminate new information; and the less likely that a broad base of investors understand the context of that information.

A European study measuring excess returns generated by stocks after surprise earnings results compared the outcome before and after companies adopted wire services (or news agencies) to broadcast news widely.

The study found that even though new information was more rapidly priced in after the adoption of wire services, with stronger initial reactions and lower post-earnings price “drift”, it still takes time for markets to fully react to material new information. This is illustrated in the chart below.

Excess returns from earnings surprises before & after adoption of wire service

Source: News Dissemination and Investor Attention (Boulland, Degeorge & Ginglinger, May 2016)

So for the investor who happens to have done the right homework and immediately understands the implications of new information, time is on their side.

Even at the macro level, there is evidence prices do not rapidly adjust to new information.

A 2017 study by Columbia University academics Calomiris & Mamaysky examined news flow and pricing in 51 stock awards markets and concluded that “Economic and statistical significance are high and larger for year-ahead than monthly predictions” - ie rather than immediately re-pricing, markets take time to adjust to new information.


Comments

Please sign in to comment on this wire.
Medium screen shot 2018 03 01 at 5.01.10 pm

Alex Cowie

Very interesting wire, thanks Martin. It's good to see the latency in response to earning changes so clearly demonstrated.

Medium screen shot 2017 02 28 at 8.02.18 pm

Patrick Poke

Great read Martin. I think it's particularly interesting that the share prices appear to begin moving in the correct direction a few days before the announcement.

Avatar fallback

Michael Hill

I agree with Patrick, insider trading appears to be alive and well as difficult it may be to prove.

Avatar fallback

Norman Taralrud-Bay

Patrick and Michael, this was also my instant reaction to the graph. Pity our 'regulators' have a tick the box mentality and do not enforce more onerous investigations (and penalties)

See 1 more comment