A Computational View of Market Efficiency

From Meritology

Author's 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.

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Resource: [1] Author: Jasmina Hasanhodzic, Andrew W. Lo, and Emanuele Viola Title: A Computational View of Market Efficiency