Presidential Address: Sophisticated Investors and Market Efficiency

  • Author(s): JEREMY C. STEIN
  • Published: Jul 16, 2009
  • Pages: 1517-1548
  • DOI: 10.1111/j.1540-6261.2009.01472.x


Stock‐market trading is increasingly dominated by sophisticated professionals, as opposed to individual investors. Will this trend ultimately lead to greater market efficiency? I consider two complicating factors. The first is crowding—the fact that, for a wide range of “unanchored” strategies, an arbitrageur cannot know how many of his peers are simultaneously entering the same trade. The second is leverage—when an arbitrageur chooses a privately optimal leverage ratio, he may create a fire‐sale externality that raises the likelihood of a severe crash. In some cases, capital regulation may be helpful in dealing with the latter problem.

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