Market anomaly

A market anomaly (or inefficiency) is a price and/or return distortion on a financial market.
It is usually related to:

• either structural factors (unfair competition, lack of market transparency, ...)
• or behavioral biases by economic agents (see behavioral economics)

It sometimes refers to phenomena contradicting the efficient market hypothesis. There are anomalies in relation to the economic fundamentals of the equity, technical trading rules, and economic calendar events.
Anomalies could be Fundamental, Technical or calendar related. Fundamental anomalies include value effect and small-cap effect (low P/E stocks and small cap companies do better than index on an average. Calendar anomalies involve patterns in stock returns from year to year or month to month, while technical anomalies include momentum effect.

Adaptive market hypothesis

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The Adaptive Market Hypothesis, as proposed by Andrew Lo (2004,2005), is an attempt to reconcile theories that imply that the markets are efficient with behavioral alternatives, by applying the principles of evolution - competition, adaptation, and natural selection - to financial interactions. ^[1]
Under this approach the traditional models of modern financial economics can coexist alongside behavioral models. He argues that much of what behavioralists cite as counterexamples to economic rationality - loss aversion, overconfidence, overreaction, and other behavioral biases - are, in fact, consistent with an evolutionary model of individuals adapting to a changing environment using simple heuristics.
According to Lo, the Adaptive Markets Hypothesis can be viewed as a new version of the efficient market hypothesis, derived from evolutionary principles. "Prices reflect as much information as dictated by the combination of environmental conditions and the number and nature of "species" in the economy." By species, he means distinct groups of market participants, each behaving in a common manner (i.e. pension funds, retail investors, market makers, and hedge-fund managers, etc.). If multiple members of a single group are competing for rather scarce resources within a single market, that market is likely to be highly efficient, e.g., the market for 10-Year US Treasury Notes, which reflects most relevant information very quickly indeed. If, on the other hand, a small number of species are competing for rather abundant resources in a given market, that market will be less efficient, e.g., the market for oil paintings from the Italian Renaissance. Market efficiency cannot be evaluated in a vacuum, but is highly context-dependent and dynamic. Shortly stated, the degree of market efficiency is related to environmental factors characterizing market ecology such as the number of competitors in the market, the magnitude of profit opportunities available, and the adaptability of the market participants (Lo,2005).

[edit] Implications

The AMH has several implications that differentiate it from the EMH such as:

1. To the extent that a relation between risk and reward exists, it is unlikely to be stable over time.
2. Contrary to the classical EMH, there are arbitrage opportunities from time to time.
3. Investment strategies will also wax and wane, performing well in certain environments and performing poorly in other environments. This includes quantitatively-, fundamentally- and technically-based methods.
4. Survival is the only objective that matters while profit and utility maximization are secondary relevant aspects
5. Innovation is the key to survival because as risk/reward relation varies through time, the better way of achieving a consistent level of expected returns is to adapt to changing market conditions.

Transparency (market)

In economics, a market is transparent if much is known by many about:

• What products, services or capital assets are available.
• What price.
• Where.

There are two types of price transparency: 1) I know what price will be charged to me, and 2) I know what price will be charged to you. The two types of price transparency have different implications for differential pricing.^[1]
This is a special case of the topic at transparency (humanities).
A high degree of market transparency can result in disintermediation due to the buyer's increased knowledge of supply pricing.
Transparency is important since it is one of the theoretical conditions required for a free market to be efficient.
Price transparency can, however, lead to higher prices, if it makes sellers reluctant to give steep discounts to certain buyers, or if it facilitates collusion.
While the stock market is relatively transparent, hedge funds are notoriously secretive. Some financial professionals, including Wall Street veteran Jeremy Frommer are pioneering the application of transparency to hedge funds by broadcasting live from trading desks and posting detailed portfolios online.