On the Static Efficiency of Secondary Bond Markets

Efficiency in the context of financial markets can be defined in many ways. The major strand of finance literature measures the market’s ability to process information into prices. Another strand of literature refers to the economists’ usual sense of the word, i.e. that markets ensure that resources are allocated to their most profitable use, and provide services at the lowest cost in terms of the resources employed. This paper, deploying the second definition, suggests a concept of static efficiency and claims that this efficiency can also be seen as a measure of the quality of a market. The paper develops a measure of qualitative static efficiency for bond markets built on four indicators: transparency, number of maturities and issuers, spread, and liquidity. Indicators of market quality should be easily accessible by those that are intending to use it. Using Nordic markets as case studies, we show that these markets became more economically efficient during the 1990’s, but that transparency of efficiency remains a problem.

Introduction: Efficiency in the context of capital markets has been defined in many ways. To many researchers, it is a question of how much information is available to market participants, and how market participants handle that information. According to this view, known under the rubric of the efficient markets paradigm (or hypothesis), an efficient bond market would be one where bond prices accurately reflect all available information (Fama 1997, 1970), and quickly adjusts to new information (Fama et.al 1969). It is assumed within the efficient markets hypothesis, which traditionally contains three important sub-groups associated with the kinds of information being considered1, that market participants rationally formulate their bond buying and selling decisions based on available information about bond prices and their relevant determinants.But markets are also economic institutions that require resources and economic agents. Efficient markets in this wider economic sense are involved in allocating resources to their most profitable use and in cost effective ways.

Author: Lars Oxelheim,Michael Rafferty

Source: Institute of Economic Research, Lund University

Download URL 2: Visit Now

Leave a Comment