Bond Market Efficiency

When discussing the efficiency or inefficiency of the US bond market, one of the most important metrics to zero in on is that of price adjustments to new information. For a market to be deemed highly efficient, securities would be expected to reflect historic and public information nearly immediately in their prices leaving nearly no time for profiting off of information discrepancies. Additionally, an optimal method for determining the relative efficiency of the bond market is the side by side comparison of certain metrics with those of the equities markets. What we find from this analysis is that the US bond market as a whole tends to be at least as efficient in many aspects as that the US equities markets.

Before pointing out what makes the bond market efficient, it is important to point out some of the cases that would run contradictory to such a claim. Two major ways by which bond portfolio managers could make profit is through interest rate forecasting and the identification of mispricing in the bond market, both due to insight superior to that of the market (Bodie, Kane, Marcus 359). If active managers are able to obtain superior information and successfully adjust portfolio duration to changing interest rates or identify mispricings, then they will profit because of market inefficiencies.

While the existence of the factors mentioned above would serve to discredit the theory of efficient markets, the following conditions must be met in order for bond markets to be deemed efficient. The three factors that should cause the bulk of daily fluctuations in corporate bond prices are “changes in risk-free Treasury rates of interest, changes in risk-premiums for similar-risk corporate bonds, and changes in the company’s likelihood of default on its obligations (Hartzmark 12).” In terms of the effects of new information, firm-specific information not related to the firm’s default risk should not move the bond price, while certain impactful macroeconomic events can...