(Pictures are worth some number of words you know.)

If markets are efficient then price movements happen because of news that changes the value of assets.  Often however stock prices seem to fluctuate even in the absence of any new information.  On Black Monday in 1987, US stocks dropped by more than 20% without any obvious reason in terms of information about fundamentals. Are asset price movements simply random, or worse, a result of manipulation?

The question is impossible to answer using data from today’s markets.  How can you independently identify what is news?  And even when there is verifiably no news how can you rule out the possibility that prices moved precisely because of the absence of some expected good or bad news?

Peter Koudijs has found a wonderful historical episode in which it is possible to identify precisely the days in which news arrives and to measure the effect of news on stock prices.  During the 18th century there were a few English companies whose stock was traded both in London and in exchanges in Amsterdam. When the prices of these stocks changed in London, information about the price movements reached Amsterdam via mail boats that crossed the North Sea. When weather prevented these boats from crossing, news was delayed.  These weather events enable him to show that a large component of price volatility is directly attributable to the arrival of news. This dramatic picture pretty much summarizes it:

On the 19th of November, shares of the British East India Company (EIC) began to drop in response to a speech given by British Prime Minister Fox who spoke of  “the deplorable state” of its fiances.  Bad weather delayed the arrival of boats from England to Amsterdam until around the 27th of November.  In the intervening period, there was little change in the price of EIC shares on the Amsterdam exchange.  But as soon as the boats arrive, the stock price dropped to the level seen on the London exchange a week earlier.

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