15 November 2019
Immy, a student on our MSc in Finance, Technology and Policy programme, shares her reflections on a topic she's been studying this semester.
This semester on the Master's in Finance, Technology and Policy we have been studying the Efficient Market Hypothesis (EMH). The EMH states that shares that shares will be traded at fair prices. In other words, share prices reflect all of the information, and the market reacts quickly to new information so that no market participants can generate consistent, risk-adjusted abnormal returns.
Many scholars argue that the market is currently far from efficient. For instance, when there is new information, there is evidence to point out that the market overreacts. The prices often initially over-surge or over-plunge before adjusting to a new price, instead of adjusting to a new price straight away in a timely manner.
However, I think there are three reasons that the socio-technological zeitgeist of the new generation of market participants may direct the financial markets faster to an efficient direction in the near future.
1. The New Generation is Becoming More Educated
The data from Pew Research Center shows the generation-over-generation uptrend of education attainment. Around 39% of millennials hold a bachelor's degree or higher, compared to 29% for Generation Xers and 25% for Late Boomers. eLearningInside suggests that this trend will also continue with post-millennials.
Higher education develops critical thinking skills and thus can lead to less of a 'herding' effect or the likelihood of being deceived by fake news. The new generation is also internet-native (although digital adoption is on the uptrend for every generation). This means they have faster and greater access to new information, including the high-tech trading techniques such as High Frequency Trading (HFT), hence the faster disappearance of arbitrage opportunities.
2. The New Generation Values Travelling
Travelling is more of a priority among millennials than the previous generation, according to AARP's 2019 Travel Trends report. Although travelling and efficient markets may seem unrelated at first glance, travelling is an opportunity to see investment opportunities in new places and gain access to local information, breaking the information barrier in international trading.
Investments from foreigners bring more liquidity to currently illiquid markets. Liquidity is a crucial factor in making the market efficient, but is lacking in some emerging markets, such as the markets in the Asia-Pacific region. An increase in liquidity can drive the prices in such markets to the fair value, making the abnormal returns disappear.
3. Low Inflation Reflects True Return More Accurately
Low inflation is a 'new normal'; it occurs as a contagion around the world, not only in Japan, but also in Europe and the US. Although policy makers are worried about the economic stagnation that could result from too low inflation, this 'new normal' does not necessarily imply a bad thing.
Inflation can be the noise of a forecast, therefore low inflation can help real growth, making real return forecasting easier and more accurate. Investors will be confident when investing in the markets with a higher rate of return, because they do not have to worry too much about the confusion between the signal of higher real return and higher inflation. The capital would hence quickly flow to the markets where there is excess return, forcing the undervalued asset price to reflect the fair price.
This has been an interesting topic for me to study, and I have enjoyed researching the data available and forming my own thoughts on the subject. I'm looking forward to studying topics like this in more depth throughout the semester.
Further Reading
Immy is a Thai student on the MSc in Finance, Technology and Policy