Bhattacharya & O'Brien on Market Efficiency

Rajeev R. Bhattacharya and Stephen O'Brien have posted Arbitrage Risk and Market Efficiency - Applications to Market Efficiencyon SSRN with the following abstract:

Measuring the efficiency of the market for a stock is important for a number of reasons. For example, it determines the necessity for an investor to acquire expensive additional information about a firm, and it is a critical factor in class certification in a securities class action. We provide a general methodology to measure the arbitrage risk, which is a negative proxy for the market efficiency, of a stock for any relevant period. We apply this methodology to calculate the arbitrage risk of each U.S. exchange-listed common stock for every calendar year from 1988 to 2010. We find that market efficiency is significantly affected by turnover (negatively), the number of market makers for Nasdaq stocks (negatively), and serial correlation in the Capital Asset Pricing Model of the stock (positively). These findings seem inconsistent with “conventional wisdom,” but we show that our findings are consistent with economic logic. The relations between market efficiency and market capitalization (positive), bid-ask spread (negative) and institutional ownership (positive) are consistent with conventional wisdom. The impact on market efficiency of the number of securities analysts following a stock and the public float ratio of a stock are of ambiguous significance.