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Matt Levine

High-Frequency Trading May Be Too Efficient

I suspect, but cannot prove, that there is a financial blogging analogue of the Grossman-Stiglitz paradox that proves that no one should write anything.

If by some ghastly mistake I were put in charge of regulating the world's financial markets, my first order of business would be to find an organizing principle or slogan or whatever to direct my regulating. "Fairness" and "transparency" and "looking out for the little guy" seem to be popular slogans for the world's actually existing market regulators, but I think my slogan might be "the Grossman-Stiglitz paradox." This is the idea that if markets are efficient -- if market prices accurately reflect all the information in the world -- then there's no incentive for anyone to invest any time or money or effort into finding more information. And if no one goes looking for information, then there's no way for market prices to be accurate.

This is not, like, a huge thing to worry about in your everyday life, though it raises some potentially interesting questions about your index funds. But as a regulator I would seek ways for markets to be optimally inefficient -- that is, just inefficient enough to promote the information-gathering work that makes them efficient. And this might help organize my thoughts about insider trading, for instance, or about when activist investors should have to disclose their stakes in their target companies.