1. Prof. Avner Kalay - Investments Pure Efficiency is impossible - $100 on the ground - If the markets are totally efficient prices reflect all available information - Therefore there are no returns on information acquisition. - There will be no costly collection of information - So why would prices reflect the new information?

2. Prof. Avner Kalay - Investments Tests of Market Efficiency – Weak Form - Weak forms: These test attempt to find out if one can make abnormal profits by following investment strategy that uses only the history of prices. - An investment strategy based on technical analysis would be evidence of inefficiency in the weak form. - Early tests show that there is not much value in charts.

3. Prof. Avner Kalay - Investments Tests of Market Efficiency – Weak Form - The Weekend effect – Prices on close of Friday higher than open on Monday. The difference is smaller than the transaction costs. - January effect – the return of small firms during the first week of January are abnormally high. The phenomenon appeared in Australia where the tax year is different - Data Snooping

4. Prof. Avner Kalay - Investments Tests of Market Efficiency – Weak Form? - Kalay and Wohl (2009). - Informed traders are more sensitive to market prices than uninformed. - Hence there is information in the shape of the demand and supply curve during the opening session at the TASE. - If the demand (supply) curve is steeper than the supply (demand), the stock price is likely to go down (up) from the opening to the closing.

5. Prof. Avner Kalay - Investments The Idea Three informed investors and liquidity traders. Investor 1 excess demand: q 1 = 10 – p Investor 2 excess demand: q 2 = 12 – p Investor 3 excess demand: q 3 = 14 – p We break the excess demand of strategic investors to demand and supply.

6. Prof. Avner Kalay - Investments Tests of Market Efficiency – Weak Form?

7. Prof. Avner Kalay - Investments Tests of Market Efficiency – Weak Form?

8. Prof. Avner Kalay - Investments Tests of Market Efficiency – Weak Form? At the equilibrium price of $12 investor 3 buys 2 units from investor 1 while investor 2 stay out of the market. Now introduce asymmetric presence of liquidity traders. Liquidity supply of 1 unit and liquidity demand of 2 units.

9. Prof. Avner Kalay - Investments Tests of Market Efficiency – Weak Form?

10. Prof. Avner Kalay - Investments Tests of Market Efficiency – Weak Form? The larger presence of liquidity buys push the equilibrium price to $12.333. At this price investor 1 supplies 2.333, investors 2 supplies 0.333 and investor 3 demands 1.666. Only one strategic investor buys while two are selling.

11. Prof. Avner Kalay - Investments Tests of Market Efficiency – Weak Form? - The economic value is still $12 hence we expect a price drop. - KW (2009) measure the relative slope of the demand and the supply and use it to predict the return during the day - Flatter supply (demand) -- informed are selling (buying) and prices will drop

12. Prof. Avner Kalay - Investments Tests of Market Efficiency – Weak Form? M = |slope of the demand|/ [slope of the supply + |slope of the demand|] Without the liquidity traders M = 1/{1+1} = 1/2 With more liquidity buyers M = 1/{1+2}=1/3

13. Prof. Avner Kalay - Investments Tests of Market Efficiency – Weak Form? R j,t,open to close =  j +  j M open,t +  j,t t=1,2,..,167 days j = 1,2,..,105 stocks Average  = 2.349 with t of 29.83 Average adjusted R square = 0.139

14. Prof. Avner Kalay - Investments Tests of Market Efficiency – Weak Form? - Can one make money using this model? - Not clear. - We used all the information in the limit order book while the market has only the most extreme three. - Knowing the book is valuable.

15. Prof. Avner Kalay - Investments The book Orders to Sell 100 at $106 70 at $105.9 80 at $105.8 Orders to Buy 95 at $105.6 110 at $105.4 200 at $105.1

16. Prof. Avner Kalay - Investments Earnings momentum Event time Stock returns E↑E↑ E↓E↓