New Paper: A computational view of Market Efficiency

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New Paper: A computational view of Market Efficiency

September 1, 2009 by algorithmicgametheory

An intriguing new paper, A computational view of Market Efficiency by Jasmina Hasanhodzic, Andrew W. Lo, and Emanuele Viola has just been uploaded to the arXiv.

Abstract

We propose to study market efficiency from a computational viewpoint. Borrowing from theoretical computer science, we define a market to be efficient with respect to resources $S$ (e.g., time, memory) if no strategy using resources $S$ can make a profit. As a first step, we consider memory- $m$ strategies whose action at time $t$ depends only on the $m$ previous observations at times $t-m,...,t-1$ . We introduce and study a simple model of market evolution, where strategies impact the market by their decision to buy or sell. We show that the effect of optimal strategies using memory $m$ can lead to “market conditions” that were not present initially, such as (1) market bubbles and (2) the possibility for a strategy using memory $m' > m$ to make a bigger profit than was initially possible. We suggest ours as a framework to rationalize the technological arms race of quantitative trading firms.