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Reply: The Optimal Price to Trade

Published online by Cambridge University Press:  06 April 2009

Ben Branch
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Extract

Edward Miller's basic point (see “Comment” in this issue) may be put rather briefly: If market prices follow the random walk model precisely (I assume he refers to the semi-strong form of the efficient market hypothesis), there are no gains to be made from a trading strategy which involves waiting for more attractive prices. In a fully efficient market the price is always in line with the available information and thus never becomes either more or less attractive than the relevant information set would allow.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 14 , Issue 3 , September 1979 , pp. 649 - 651
Copyright
Copyright © School of Business Administration, University of Washington 1979

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References

1 B. Branch, “Testing the Unbiased Expectations Theory of Interest Rates,” Financial Review, forthcoming in Gleit, A. and Branch, B., “The Black Scholes Market with Separated Markets,” unpublished working paperGoogle Scholar.

2 Branch, B., “A Tax Loss Trading Rule,” Journal of Business (04 1977), pp. 198–207CrossRefGoogle Scholar; McNally, R., “Stock Price Changes Induced by Tax Switching,” Review of Business and Economic Research (Fall 1976), pp. 47–54Google Scholar; Branch, B. and Ryan, C., “Tax Loss Trading: An Inefficiency Too Large to Ignore,” unpublished workingpaperGoogle Scholar.

3 Branch, B., ”The Optimal Price to Trade,” Journal of Financial and Quantitative Analysis (09 1975), pp. 506–607.Google Scholar

4 Smidt, S., “A New Look at the Random Walk Hypothesis,” Journal of Financial and Quantitative Analysis (09 1968), pp. 235–262CrossRefGoogle Scholar.

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6 Basu, S., “The Information Content of Price Earnings Ratios,” Financial Management (Summer 1975), pp. 53–63Google Scholar; Basu, S., “The Investment Performance of Common Stocks in Relation to Their Price Earnings Ratio: A Test of the Efficient Market Hypothesis,” Journal of Finance (06 1977), pp. 663–682CrossRefGoogle Scholar.

7 “IBM Stock Manipulated by Chicago Firm to Sway Opition's Price, SEC Staff Says,” Wall Street Journal (October 25, 1978), p. 20.

8 Finnerty, J., “Insiders and Market Efficiency,” Journal of Finance (09 1976), pp. 1141–1148CrossRefGoogle Scholar.

9 Reilly, F., “Further Evidence on Short-Run Results for New Issue Investors,” Journal of Financial and Quantitative Analysis (01 1973), pp. 91–104Google Scholar.

10 Branch, B., “The Predictive Power of Market Indicators,” Journal of Financial and Quantitative Analysis (01 1973), pp. 91–104Google Scholar.

11 Grier, P. and Albien, P., “Nonrandom Price Changes in Association with Trading in Large Blocks,” Journal of Business (07 1973), pp. 423–433Google Scholar.

12 Niederhoffer, V. and Osborne, M., “Market-Making and Research on the Stock Stock Exchange,” Journal of the American Statistical Association (12 1966), pp. 897–917CrossRefGoogle Scholar.

13 Miller also appears to believe that a significant number of price inefficiencies exiśt (“speculative stocks” is the term he uses). Apparently we differ over the extent of such differences.

14 Miller correctly indicates that my suggested approach is a type of filter rule. It should, however, be noted that my approach differs in two ways from those used to a filter rule approach test of the weak form of the efficient market hypothesis. First, my filter level should be varied both with respect to the prior volatility of the stock in question and the individual's willingness to wait. Second, my approach presumes that the investor wants to select appropriate timing for a one-way trade. The traditional filter rule studies, in contrast, use a filter level which does not vary from stock to stock and assume a round trip trading strategy (thereby requiring that transactions costs be overcome). Accordingly evidence regarding the value of these traditional filter rules does not reflect on the value of the proposed approach.