For decades, the efficient market hypothesis has dominated legal and economic thinking about securities markets. Courts routinely rely on the “fraud-on-the-market” doctrine, which presumes that stock prices reflect all publicly available information – a presumption that underpins most securities class actions today. But what if this foundational assumption oversimplifies how markets actually process information?
Our new research, examining over 2,100 trading halts across 96 dual-listed U.S.-Israel securities from 2007-2024, reveals that the costs of processing information play a crucial role in market efficiency that has been largely overlooked by both academics and regulators. The findings challenge the traditional view that public information is automatically and costlessly incorporated into stock prices, with significant implications for securities law, market regulation, and corporate disclosure practices.
The Natural Experiment
Our study exploits a unique institutional setting that creates what amounts to a natural experiment in information processing costs. Under Israeli securities law, companies dual-listed on both U.S. exchanges and the Tel Aviv Stock Exchange (TASE) must halt trading in Tel Aviv for 30 minutes when releasing material information to the public. Crucially, no corresponding halt occurs on U.S. exchanges, meaning the same security continues trading in New York while being halted in Tel Aviv.
As a result of this differential trading halt, Israeli traders, who typically face lower processing costs for these securities due to language familiarity, local information advantages, and specialized knowledge of Israeli companies, are temporarily prevented from trading. Meanwhile, U.S. traders continue to trade, but face higher processing costs when digesting Hebrew-language disclosures and Israel-specific information.
The result is a temporary but forced increase in processing costs in the market for the security during the 30-minute halt period. If processing costs matter for market efficiency, we should observe deteriorating market quality during these periods.
Striking Evidence of Market Deterioration
The data show that processing costs matter. During TASE trading halts, U.S. markets experience significant increases in illiquidity and volatility across multiple measures:
- Bid-ask spreads increase by 29% (dollar terms) and 54% (percentage terms)
- Effective spreads rise by 14% of a standard deviation
- Market depth decreases by 49%
- Price volatility increases by 21%
These effects are not subtle – they represent substantial deteriorations in market quality that occur precisely when lower-processing-cost traders are excluded from the market.
Ruling Out Alternative Explanations
To ensure these findings reflect the causal impact of processing costs rather than other factors, we conducted extensive robustness tests. A regression discontinuity design exploiting the sharp 30-minute regulatory cutoff shows that market quality improves discontinuously at the moment Israeli traders can resume trading.
We conducted two falsification tests. First, we examined similar material news events at matched U.S. firms that were not subject to trading halts – and found no corresponding deterioration in market quality. Second, we studied the predictable daily closing of the TASE (a mechanical liquidity shock without new information) and again found no comparable effects. These tests strongly suggest that the temporary removal of lower-processing-cost traders, rather than generic reactions to news or liquidity shocks, drives our results.
Implications for Securities Law and Regulation
These findings have profound implications for how we think about securities markets and their regulation.
Rethinking Market Efficiency: The traditional legal framework assumes that public information is immediately reflected in prices. Our evidence suggests this view is incomplete. Markets are more efficient when they include traders with lower processing costs, and efficiency can be temporarily impaired when these traders are excluded. This has direct implications for the fraud-on-the-market doctrine and the presumption of efficient markets that underlies much of securities litigation.
Disclosure Policy: Current disclosure regimes focus primarily on making information “public” but pay little attention to how different market participants process that information. Our findings suggest that regulators should consider not just whether information is disclosed, but how processing costs affect the speed and accuracy with which that information is incorporated into prices.
Market Structure: The results highlight how institutional frictions- in this case, clearing and settlement differences that prevent Israeli traders from easily shifting to U.S. markets – can have first-order effects on market quality. As markets become increasingly global and interconnected, understanding these frictions becomes more important.
Cross-Border Trading: While dual-listing theoretically provides continuous trading opportunities across markets, our findings show how institutional barriers can create de facto market segregation. This suggests the benefits of cross-listing may be more limited than previously thought when trading frictions prevent efficient arbitrage.
The Broader Picture
Our research contributes to an emerging literature that views information processing as a costly activity requiring dedicated resources and expertise. This perspective has important implications beyond the specific U.S.-Israel context we study.
The heterogeneity in our results is particularly revealing. Effects persist across firms of all sizes, from small-cap to large-cap companies. This suggests that the advantages of specialized information processing – whether linguistic, cultural, or analytical – matter even for well-followed, liquid securities. In an era of increasingly complex corporate disclosures and global business operations, heterogeneity in processing costs among market participants may have become even more important for understanding how markets function.
Looking Forward
Several contemporary trends make these findings increasingly relevant. The rise of algorithmic trading has created new forms of processing cost advantages based on computational speed and sophistication. Increasing globalization means more securities are traded across multiple jurisdictions with different regulatory frameworks and trader populations. And the growing complexity of corporate disclosures – from sustainability reporting to complex financial instruments – creates new dimensions along which processing costs can vary.
For corporate governance practitioners, these findings suggest that how and where companies disclose information may matter as much as what they disclose. For regulators, they highlight the need to consider the full ecosystem of market participants when designing disclosure rules and market structure regulations.
The traditional view that efficient markets automatically incorporate all public information has served as a useful approximation for many purposes. But our evidence suggests that this view, while not incorrect, is incomplete. In reality, market efficiency depends critically on the presence of market participants with the ability and incentive to process information quickly and accurately. When regulatory or institutional frictions exclude these participants, even temporarily, market quality can suffer in ways that affect all investors.
The literature has long examined the mechanisms of market efficiency (e.g., Gilson & Kraakman, 1984). Our study shows that processing costs are an underappreciated mechanism that should be better understood to achieve the policy goal of fair, efficient, and liquid markets in the global financial system.