Transaction Costs and Market Efficiency

Previous research suggests that a decline in transactions costs leads to improved economic efficiency. In this paper,weshowthatsuchadeclinewillintroduceincreasinglyuninformedconsumersintoestablished markets. Using a model of financial market inefficiency, we show that this increase in uninformed individuals can increase market risk (volatility), can decrease efficiency, and may reduce social welfare even when market participants are perfectly rational. We then test the predictions of our model using data on the retail equities market. Our results suggest that securities that have a large proportion of small trades (presumably disproportionately from small, online retail investors) tend to be less efficient by conventional measures, consistent with our model predictions.

• Type: Conference
• Year: 2001
• Where: ICIS
• Authors: Bin Gu, Lorin M. Hitt
• Keywords: Financial Market Inefficiency, ICIS 2001, Improved Economic Efficiency, Information Technology, Retail Equities Market