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 (
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
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.