Information Diffusion and the Boundary of Market Efficiency

The study investigates the boundary of marketefficiency and the diffusion mechanism in capitalmarkets. A stylized information diffusion model ispresented to describe the process by which investorsgradually assimilate the information following aninformation event. The model suggests that adiffusion process depends on both a drift and adiffusion force. If prices have converged before thedrift force disappears, the diffusion phenomenon isdifficult to observe. Otherwise, the diffusionforce dominates in the longer horizon and imposes aboundary on market efficiency. The model indicatesthat the speed of information diffusion depends oninformation content, information conductivity, andinformation shock absorption capacity. Each signalhas a different degree of information content, andeach firm has a unique information conductivity.Consequently, the information on different firmsdiffuses across investors at different rates.Several implications from this diffusion model aretested with quarterly earnings announcement data.The findings are consistent with an informationdiffusion process at work in capital markets.

Autorentext

Dr. Hai Lu is on the faculty of management at the University of Toronto. He has Ph.D. in Business Administration from the University of Southern California. He also studied thermal physics at the Australia's CSIRO and Chinese Academy of Sciences. His research findings were featured in the Wall Street Journal and other medias.

Klappentext
The study investigates the boundary of market efficiency and the diffusion mechanism in capital markets. A stylized information diffusion model is presented to describe the process by which investors gradually assimilate the information following an information event. The model suggests that a diffusion process depends on both a drift and a diffusion force. If prices have converged before the drift force disappears, the diffusion phenomenon is difficult to observe. Otherwise, the diffusion force dominates in the longer horizon and imposes a boundary on market efficiency. The model indicates that the speed of information diffusion depends on information content, information conductivity, and information shock absorption capacity. Each signal has a different degree of information content, and each firm has a unique information conductivity. Consequently, the information on different firms diffuses across investors at different rates. Several implications from this diffusion model are tested with quarterly earnings announcement data. The findings are consistent with an information diffusion process at work in capital markets.