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Limited profit in predictable stock markets

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  • R. Rothenstein
  • K. Pawelzik

Abstract

It has been assumed that arbitrage profits are not possible in efficient markets, because future prices are not predictable. Here we show that predictability alone is not a sufficient measure of market efficiency. We instead propose to measure inefficiencies of markets in terms of the maximal profit an ideal trader can take out from a market. In a stock market model with an evolutionary selection of agents this method reveals that the mean relative amount of realizable profits $P$ is very limited and we find that it decays with rising number of agents in the markets. Our results show that markets may self-organize their collective dynamics such that it becomes very sensitive to profit attacks which demonstrates that a high degree of market efficiency can coexist with predictability.

Suggested Citation

  • R. Rothenstein & K. Pawelzik, 2004. "Limited profit in predictable stock markets," Papers cond-mat/0403621, arXiv.org, revised Mar 2004.
    • Handle: RePEc:arx:papers:cond-mat/0403621
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