Although day-to-day returns indicate the lack of significant serial correlation,
order imbalances can persist for several days. The lack of interday dependence
and the presence of continuing order imbalances over several days suggest that
some investors are conducting countervailing trades to correct the order
imbalance and that this activity removes serial dependence in returns within the
trading day. The authors investigate how long it takes the market to remove this
return dependence and make the market weak-form efficient. Their results show
that it takes more than 5 minutes but less than 60 minutes.
Research on the efficiency of security markets indicates that markets are generally
efficient and security prices are difficult to predict, at least for large stocks in
developed markets. These markets are efficient in the weak-form sense, as they do not
exhibit significant levels of serial correlation of returns. Markets, however, do not
magically become efficient but do so through the actions of individual investors. What
process is used to make the markets efficient, and how long does it take? This is the
issue addressed by the authors.
They focus on market order imbalances for the S&P 500 Index stocks as documented by
Chordia, Roll, and Subrahmanyam (
Market order imbalances, defined as aggregate daily purchase orders less sell orders,
were found to be highly predictable from day to day. High imbalances on one side of the
trade were found to persist for several days. Despite the persistence in orders, the
S&P 500 essentially followed a random walk over a horizon of one day. Thus, the
results indicate that although the returns are random and exhibit weak-form efficiency
on a day-to-day basis, order imbalances could persist for at least several days. This
finding suggests that some perceptive investors are correctly forecasting continued
price pressures and conducting countervailing trades sufficient to remove serial
dependence in returns. The removal of serial dependence on a day-to-day basis does not
mean, however, that the process takes place instantaneously. Some finite time period is
most likely required during the day for investors to ascertain what is going on and to
complete trading decisions that expunge any serial dependence remaining for the trading
day. How long it takes to achieve this degree of weak-form efficiency is the question
addressed by this research.
The data used cover 150 large-capitalization stocks listed on the NYSE for the 1996,
1999, and 2002 calendar years. Each transaction for each of the stocks is taken from the
Trade and Automated Quotations (TAQ) database of the NYSE. The Lee and Ready
(
estimate whether a particular trade is initiated by the buyer or seller. Several
measures of order imbalance (buyer-initiated trades less seller-initiated trades) were
calculated for various time intervals during each trading day. The authors first
ascertain whether returns are serially dependent during the trading day, thus confirming
weak-form efficiency. Using intraday returns for the 150 stocks, there appears to be
little evidence of unconditioned serial dependency of returns. Using only the past
history of returns, there is little predictability of future returns over intervals even
as short as five minutes.
Lagged order imbalances, however, are shown to be significant predictors of returns at
intervals up to 30 minutes in 1996, up to 10 minutes in 1999, and up to 5 minutes in
2002. Thus, in less than 30 minutes, order imbalances lose their predictive ability.
This evidence is consistent with countervailing trades being undertaken. Within a short
period of at most 30 minutes, the market appears to lack strong-form efficiency.