Question

Define an Efficient Market. What factors would tend to promote efficiency? Outline the implications of market efficiency for (i) Directors and Managers of firms and (ii) Market regulators.

Is the factors that promote efficiency > Information available in the market?

And how does it impact the directors, and regulators?

Answer 1

Market efficiency refers to the extent all the information available (public as well as private) on the security is factored in its price. Efficient markets are the markets wherein all the stock related information is factored in the stock prices. The efficient market hypothesis (EMH) classifies markets in three forms

1. Strong Form: the security price reflects all the public and private information relevant to the security. Since, the current price reflects all information, public as well as private, hence no investors will be able to consistently find undervalued stocks. This means even an insider will not be able to generate abnormal returns.
2. Semi-strong Form: All the publicly available information (and not the private information) is incorporated in security prices. Since the current price reflects the information contained not only in past prices but all public information (including financial statements and news reports), an insider (with private information) can continuously find undervalued stocks and generate abnormal returns.
3. Weak Form: The security price reflects only recent price movements. The current price reflects the information contained in all past prices, suggesting that charts and technical analyses that use past prices alone would not be useful in finding undervalued stocks.

Factors that promote market efficiency: are essentially those factors that enable full, quick and timely dissemination of the relevant information to the financial community.

• Transparency in disclosure of information pertaining to the business and operation
• Timely disclosure of the material information to the public
• Full disclosure of information
• Strong and well functioning market regulator
• Depth and breath in capital markets
• Responsiveness of the stock markets

The implications of market efficiency for (i) Directors and Managers of firms

1. All the information will then be public information
2. Directors and managers will not have any information that is not known in the public domain
3. There will be no insider information
4. And hence there will be no insider trading
5. Hence, the probability of making abnormal gains will be nearly zero

• and (ii) Market regulators.

1. The volatility in the market will shrink
2. Role of regulators will be simplified
3. There will be transparency
4. No surprises or sudden change in the behavior of market unless some new information flows in