Market efficiency has been a topic of interest and debate central amongst financial economists
for more than five decades. Indeed, two of the recipients of the Nobel Memorial Prize in
Economic Sciences in 2013, Eugene Fama and Robert Shiller, have debated about the efficiency
of markets since the 1980s. Concerns about market efficiency were catapulted to prominence
most recently by the financial crisis of 2007-8. Efficient capital markets are foundational to
economic theories that posit the allocative efficiency of free markets, which requires
informationally efficient capital allocation markets, such as those for equity and fixed income
trading. An extended line of research has uncovered evidence of various anomalies which seem
to challenge notions of market efficiency, and has also attempted to explain the causes of one
such anomaly, the so-called “size effect.” Though there appears to be substantial evidence that
the size effect is real and persistent, violating the efficiency market hypothesis, no substantial
evidence supports the size effect as violating market efficiency.
“In an allocationally efficient market, scarce savings are optimally allocated to productive
investments in a way that benefits everyone” (Copeland, et al., 2005, p. 353). To provide optimal
investment allocation, capital prices must provide market participants with accurate signals, and
therefore prices must fully and instantaneously reflect all available relevant information
(Copeland, et al., 2005). In advanced economies, secondary stock markets play an indirect role
in capital allocation by revealing investment opportunities and information about managers’ past
investment decisions (Dow & Gorton, 1997). For secondary stock markets, and other formal
capital markets, to efficiently and effectively fulfill these two roles, securities prices must “be good
indicators of value” (Fama, 1976, p. 133). Therefore, allocative market efficiency requires capital
market prices to be informational efficient.
Informational efficiency implies no-arbitrage pricing of tradeable securities and entails several
defining characteristics that form the basis of the efficiency market hypothesis. Generally, “A
market is efficient with respect to information set Θ_t if it is impossible to make economic profits
by trading on the basis of information set Θ_t” (Jensen, 1978, p. 98), where economic profits are
defined as risk-adjusted returns minus trading and other costs. If security prices reflect all
