Question

The purpose of this assignment is to allow the student an opportunity to explain what it means to have an efficient capital market. Students will gain an understanding of the different levels of market efficiency and how behavioral finance can inhibit reaching market transparency.

Explain in 525 words what it means to have efficient capital market, including:

• Describe the behavioral challenges in achieving efficiency.
• Discuss the three forms of market efficiency.
• What are the implications to corporate finance?
• Would you consider the real estate market an efficient capital market? Please explain why or why not.

Answer 1

Efficient Capital Market

Market efficiency is always related with market information. So in market information if it's flow properly then it will reflect in market price movements. There are three degrees of market efficiency.

1) Weak form: - When historical price movement is not reflect in present and future price movement of any stocks. That means available information is not fully equipped which can be reflect the price of the future. In this scenario excess returns can be possible through fundamental analysis. Security prices reflect all information found in past prices and volume. Often weak-form efficiency is represented as. P_t = P_t-1 + Expected return + random error _t. Since stock prices only respond to new information, which by definition arrives randomly, stock prices are said to follow a random walk.

2)Semi Strong form: When market efficiency assumes that stocks adjust quickly to absorb new information so that an investor cannot benefit over and above the market by trading on that new information which are available. Only private information unavailable to the market at large will be useful to gain an advantage in trading, and only to those who possess the information before the rest of the market does. Security prices reflect all publicly available information. Publicly available information includes. Historical price and volume information. Published accounting statements. Information found in annual reports

3)Strong Form: Says that market prices reflect all information both public and private, building on and incorporating the weak form and the semi-strong form. That means excess profit will not be possible through fundamental technical analysis. All the information is already discounted in market. Security prices reflect all information—public and private. Strong form efficiency incorporates weak and semi-strong form efficiency.Strong form efficiency says that anything pertinent to the stock and known to at least one investor is already incorporated into the security’s price.

Implication of corporate finance: -

1. The price of a company’s stock cannot be affected by a change in accounting.
2. Financial managers cannot “time” issues of stocks and bonds using publicly available information.
3. A firm can sell as many shares of stocks or bonds as it desires without depressing prices.

Efficient market theory in respect of real estate sector:

Real Estate is an Inefficient Market.The Efficient Market Hypothesis is a theory that the price of a security at any given time reflects all of the available pertinent information. That is to say that at the moment you purchase the asset, the price that you pay reflects the true value of that asset. Fair means that the price they receive for the securities they issue is the present value. Thus, valuable financing opportunities that arise from fooling investors are unavailable in efficient markets. These ideas formerly known as the Efficient Market Hypotheses (EMH) —stated that a market is efficient when prices adjust rapidly to new information (Fama). This indicates that changes in asset prices follow a random pattern and that future prices cannot be predicted based on past prices and/or other public and nonpublic information. If one follows this hypothesis, there will be no incentives for speculation. As emphasized within the EMH, an efficient market is one where prices \fully reflect all available info.

• real estate stocks, compared to aggregate level real estate data, are more likely to produce findings supporting `efficiency.
• individual level data, rather than aggregate real estate data, are more likely to produce findings supporting `efficiency.