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Macroeconomic Stability, Financial Risks and Market Eciency: Evidence for a Small and Open Economy

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  • Fernando Lefort

    ()
    (Facultad de Economía y Empresa, Universidad Diego Portales)

  • Fernando Diaz

    ()
    (Facultad de Economía y Empresa, Universidad Diego Portales)

Abstract

We analyze whether changes in external macroeconomic conditions are associated with changes in the dynamics of risk and changes in the degree of informativeness of the price system for the Chilean economy. By focusing our analysis in Chile, we hope to isolate the effect of external macroeconomic volatility from the effects that weak institutions or a poor rule of law might have over domestic markets performance. We find that the dynamics of local financial risks is associated with the evolution of the overall economic conditions of the country, with a strong reduction in idiosyncratic and systematic risks during periods of stable macroeconomic conditions. Since the level and composition of financial risks can affect the net benefits of acquiring and trading on private information, we conjecture that external economic conditions can also affect the informativeness of domestic stock prices. We find that the ability of domestic stock prices to reflect fundamentals information improves during times of stable external conditions. In spite of this, we provide evidence that traditional measures of informationally market efficiency in the R2 literature fail to detect such changes and attempt to explain the reason behind the inability of these measures to properly proxy for stock price informativeness.

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Bibliographic Info

Paper provided by Facultad de Economía y Empresa, Universidad Diego Portales in its series Working Papers with number 45.

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Date of creation: Sep 2013
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Handle: RePEc:ptl:wpaper:45

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  1. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
  2. Jacoby, Gady & Fowler, David J. & Gottesman, Aron A., 2000. "The capital asset pricing model and the liquidity effect: A theoretical approach," Journal of Financial Markets, Elsevier, vol. 3(1), pages 69-81, February.
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  7. Allen, Franklin & Carletti, Elena & Gale, Douglas, 2009. "Interbank market liquidity and central bank intervention," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 639-652, July.
  8. Tetlock, Paul C., 2006. "Does Liquidity Affect Securities Market Efficiency?," Working paper 159, Regulation2point0.
  9. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
  10. Sanford J Grossman & Joseph E Stiglitz, 1997. "On the Impossibility of Informationally Efficient Markets," Levine's Working Paper Archive 1908, David K. Levine.
  11. Amihud, Yakov, 2002. "Illiquidity and stock returns: cross-section and time-series effects," Journal of Financial Markets, Elsevier, vol. 5(1), pages 31-56, January.
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