Question

In: Finance

Explain the different forms of market efficiency and how they relate to the different forms of...

Explain the different forms of market efficiency and how they relate to the different forms of stock value analysis and insider trading.

Solutions

Expert Solution

There are generally Three types of efficient Markets and they are as follows-

A. Strong form of Efficient market advocates that all the publicly available information and the privately available information have already been discounted into the stock price and there is no scope for making an excess rate of return or Alpha by investing into the market and beating the index rate of return so an investors should always be trying to focus on investing through passive investment and index funds.

Strong form of market efficiency also advocates that that there are no probability of making an excess return through hedging and arbitraging and investor will only gain through equalling the index rate of return by passive investment so he should not be trying active investment into such markets. These kind of market will only be reacting to random informations which are new information to the market.

B. Semi strong form of market hypothesis advocates that all the privately available information is not discounted into the stock prices but publicly available information has already been discounted into the stock prices so one cannot make an excess rate of return by being a normal investor, he will need to have insider information and price sensitive private information which is available to the management in order to make an extra rate of return.

these markets are generally favouring those investors who are relatives of insiders and managements and those have access to the insider informations to make an additional rate of return.

C. Weak form of market efficiency advocates that all the historical trends and past data have already been discounted into the stock price and current prices are not reflective of the future movement so it is the weakest of all three form of market efficiency and it advocates that there is no technical analysis possible in such market because prices generally donot follow a structure and only fundamental analysis can help investors to gain an additional rate of return because there can be difference between the price and the intrinsic value of the stocks.

So, these are the market form efficiency and they are applicable to Stock Analysis and investment under different scenarios.


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