Do capital controls affect stock market efficiency? Lessons from Iceland

This paper presents analysis of market efficiency on stock index returns of five countries; Iceland, Denmark, Finland, Norway and Sweden over different periods of market liberalization and capital controls in Iceland. Although financial liberalization is often related to increased stock market efficiency, the results of this study suggest that the Icelandic stock market was relatively more efficient during periods of capital controls relative to periods of free capital flows. This evidence suggests that financial market liberalization does not necessarily lead to a more efficient stock market, at least in a small country. Comparing the efficiency of the Icelandic stock market to four other Nordic markets (Denmark, Finland, Norway, Sweden), our results show the Icelandic and Finnish stock markets to be the least weak-form efficient.