Question

(a) Efficient market hypothesis (EMH) states that the price of a security (such as a share) accurately reflects the information available. When information arrives, how fast will an information about a share be captured and reflected in the share price depends on the degree of competition among market investors. List and briefly explain, in your own words, two variations of information.

Answer 1

There are two variations of information that is reflected in the stock prices. These two variations reflect the price of a particular stock in the market. These two variations are as follows -

1. Publicly available information: This includes all information that is known to the public about the company whose stock is being traded. This includes information regarding all the financial statements issued by the company, their annual reports, the past prices of their stock, and any other informartion that is freely available to all the interested parties who are willing to invest in the stock of that company.

2. Privately available information: This includes all the information about a company that is not publicly available to everyone, but known only to few investors who have greater stakes. This includes, but is not limited to, news of an impending merger which only the top ranks of the company management will have information about, news of a new product being launched, or any such information that has the ability to affect the stock prices of that company. Such information is not available to everyone in the economy.

In situations of perfect competition, it is important that both public and private information is completely refected in the stock prices, and only then is the market called "efficient". If any investor is found to have made supernormal profit from his stock purchases (or sales), based in information that is not publicly available, it is called "insider trading" which is a federal offense and punishable in the court of law.