Question

Describe the theoretical aspects of market efficiency.

·        Please give your views and discuss the evidence for and against this theory (or hypotheses) regarding efficient markets.

·        Do you think investors use market information to make decisions?

Answer 1

Market Efficient Theory:

Market Efficient Theory refers to scenario where the market prices reflect all the available relevant information. This information could be from public and private. This theory is based on the hypothesis that the relevant available information is already incorporated in the market price of stocks and they reflect the true value of the underlying assets. In this theory, there are three levels of market efficiency explained.

Weak Form: In this scenario, the hypothesis is that the current market price already captured the available information, based on historical data, price trends etc and this shall not be an indicator for the future prices. Only any new information can have impact on the future market price.

Semi-Strong Form: This hypothesis is based on the assumption that any new published data shall have quick impact on the market prices and shall get incorporated without leaving much time gap for arbitrage/trading. Only any private information, which is unavailable in the market, shall influence for gaining advantage of trading.

Strong Form: This assumption is based on the concept that the market prices reflect all the information whether public or private and leaves no room for any further profit trading over the average investor.

Global Pandemic Situation:

In this current scenario across the globe, the global pandemic hit is an available information and every economy is hit in a bad way, irrespective of sectors or economies. The market experts, governments have already projected their revised GDPs and reduced growth/de-growth financial models, fiscal budgets etc. This has significant impact on the market prices of all the companies. With respect any company as compared to their own sector, the market prices have already been discounting the price based on the revised expectations on the quarterly sales, profit margins etc. However, any uptick on the estimates shall have positive impact on the share price, which shall be subjective to the respective company information interms of its own uptick in this pandemic situation.

Based on the Semi-Strong form hypothesis, the market price already captured the available information and have set their prices. However, any new information shall have quick response to adjust in the market price. Assuming a company has taken enough precautions and risk measures to take care of its operations and thus reported not much losses. In this case, the possibility is that the market have discounted more based on the on-going pandemic related collapses and would have estimated a more drastic fall in the revenue during the quarter. Since the revenue fall is lower than the expectations, this immediately gets adjusted /corrected in the market price with an upward tick. In this scenarion, it cannot be concluded as a failure of Market Efficient Theory.

Investors do use the market information for decision making. However, the other risk factors and comparisons are effectively analysed and discounted to conclude on the accurate information.