Presidential Address: Sophisticated Investors and Market Efficiency
JEREMY C. STEIN
Stock-market trading is increasingly dominated by sophisticated professionals, as opposed to individual investors. Will this trend ultimately lead to greater market efficiency? I consider two complicating factors. The first is crowding-the fact that, for a wide range of "unanchored" strategies, an arbitrageur cannot know how many of his peers are simultaneously entering the same trade. The second is leverage-when an arbitrageur chooses a privately optimal leverage ratio, he may create a fire-sale externality that raises the likelihood of a severe crash. In some cases, capital regulation may be helpful in dealing with the latter problem. Copyright (c) 2009 the American Finance Association.
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