Markets no more informative than they were 50 years ago

Quick summary

A recent academic paper, Have Financial Markets Become More Informative?, found that the extent to which stock and bond prices predict company earnings has not increased since 1960.


The paper starts with a quote from Eugene Fama-

The primary role of the capital market is allocation of ownership of the economy’s capital stock. In general terms, the ideal is a market in which prices provide accurate signals for resource allocation: that is, a market in which firms can make production-investment decisions… under the assumption that security prices at any time ‘fully reflect’ all available information.

So, in an ideal market prices convey information which drives investment which results in economic growth.

The authors observe that in the past 50 years there have been a number of developments that, one might think, would improve the informative role of markets, such as:

  1. Financial markets have developed tremendously in the last few decades, reducing the cost of trading and increasing liquidity.
  2. Information technology now delivers data quickly and cheaply.

So, given these developments the authors ask if market prices have become commensurately more informative. Or, to put it another way, have prices become better at predicting earnings?

To research this the authors analysed data for the S&P 500 companies since 1960.

The following figure from the paper shows the equity market-predicted variation, which measures the size of the predictable component of earnings that is due to prices, or total price informativeness in the model.

Figure 2. Forecasting earnings with equity prices. Source: Jennie Bai, Thomas Philippon, Alexi SavovThe research shows that while market prices are positive predictors of future earnings, there is no evidence of an increasing trend in equity price informativeness.

The authors conclude that their findings contradict the view that improvements in financial markets (e.g. liquidity) and information technology have increased information production.

Finally, the authors ponder why this might be; their suggestion is that while our ability to store and transmit information has undoubtedly improved, the important thing for investors is the interpretation of information *.


Bai, Jennie and Philippon, Thomas and Savov, Alexi, Have Financial Markets Become More Informative? (November 2013).

* I would just point out that the current best-selling book on investing is The Intelligent Investor by Benjamin Graham, a book first published in 1949.


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