What Affects Market Efficiency

Lack of return predictability as a criterion for market efficiency whereas microstructure literature emphasizes a separate measure of financial market efficiency; the amount of private information that is reflected in prices. According to Visaltanachoti & Yang (2010), market efficiency is affected by several characteristics of individual stocks such as trading volume, price volatility, institutional trading, market capitalization and trading cost such as information asymmetry and illiquidity. In a market efficiency research, a careful choice of these market efficiency measures is important. Informed traders incorporate information that gives them the opportunity to earn larger returns into prices and this is reflective in abnormal order flow (Cullen. Et al., 2010).

Following the methodology proposed by Chordia and Subrahmanyam(2004) and Chordia et al (2008), I will analyze the relation between stock returns and lagged order imbalance as a measure of market efficiency.Chordia and Subrahmanyam (2004), made an argument that the use of order imbalance to measure market efficiency makes sense in a market which is intermediated. In such market, market makers accommodate buying and selling pressures from the general public. Due to this, few studies has been conducted on a market that is a fully automated order-driven electronic trading system, like the Shanghai and the Hong Kong markets, where order imbalances may not be applicable. However they also emphasized that “order imbalances can signal excessive investor interest in a stock, and if this interest is autocorrelated, then order imbalances could be related to future returns”.

Yamamoto (2012) and Hu &Prigent (2017) have predicted short-horizon return with order imbalances in an order-driven market. By these justifications, I apply the Chordia and Subrahmanyam (2004) method to empirically estimate the degree of market efficiency of the Shanghai and the Hong Kong stock markets. Overview Of The Structure Of Shanghai And Hong Kong Stock MarketsSince the establishment of Shanghai stock market in 1990, it has played a tremendous role in China’s financial market development. The market has expanded rapidly in terms of market value and listed securities. Trading of equities on the SSE is fully automated order-driven mechanism on electronic system. Electronic trading allows market participants to observe and track share volumes, prices and trades of any stock on the market.

There are two trading sessions on the SSE which are used to match orders. The morning session begins with an opening call auction, from 9:15 to 9:25 and a continuous trading session from 9:30-11:30 and recommences in the afternoon from 13:00 to 15:00.During the continuous session, orders are sent through either the terminals on the trading floor or the terminals at the exchange members’ firms.The Stock Exchange of Hong Kong, on the other hand, is the primary market in Hong Kong where securities can be listed. It is known to be one of the largest in Asia; just behind China and Japan in terms of market capitalization.