On Origins of Alpha

TL;DR

This paper explores the origins of market inefficiency, highlighting how lack of mechanisms for stock price appreciation despite good earnings contributes to volatility, and proposes potential solutions to improve market efficiency.

Contribution

It introduces empirical evidence linking dividend payments to lower volatility and discusses novel mechanisms and schemes to enhance market efficiency.

Findings

Dividend-paying stocks are less volatile on average.

Market perception of earnings significantly influences stock volatility.

Proposed schemes include transaction taxes and transparent crossing engines.

Abstract

We argue that an important contributing factor into market inefficiency is the lack of a robust mechanism for the stock price to rise if a company has good earnings, e.g., via buybacks/dividends. Instead, the stock price is prone to volatility due to rather random perception/interpretation of earnings announcements (among other data) by market participants. We present empirical evidence indicating that dividend paying stocks on average are less volatile, even factoring out market cap. We further ponder possible ways of increasing market efficiency via 1) instituting such a mechanism, 2) a taxation scheme that would depend on holding periods, and 3) a universal crossing engine/exchange for mutual and pension funds (and similar long holding horizon vehicles) with no dark pools, 100% transparency, and no advantage for timing orders.