Question

Define efficient capital market. How do we know if we haven an efficient capital market?

B. Some people say that an efficient capital market is impossible to have, ever. Why do some say that efficient capital markets are impossible?

Answer 1

Efficient Capital Market is a market in which new information is very quickly reflected accurately in share prices.In other words,efficient capital markets are those markets in which security prices fully reflect all related information that is available about the fundamental value of the securities.

Insuch markets information regarding the value of securities are incorporated into its prices accurately and in real time. Since the value of securities fluctuates depending on the present value of future cash flows, an efficient capital market enables these fluctuations to be reflected in the securities' current price.

CHARACTERISTICS OF AN EFFICIENT MARKET:

1. Security prices should respond quickly & accurately to the receipt of new information that is relevant to valuation.

2. The change in security price over a period of time should be random.

3. It should be difficult to find a significant difference between the average investment performance of both those who have knowledge about the changes in values and those who don't have.

4. It should be impossible to discriminate between profitable and unprofitable investment in future.

According to the efficient capital market the market prices reflect current information. The weak thing is that past prices have no predictive power; you can’t cut market data to devise a winning long-run strategy, which contradicts the beliefs of market technicians, who look to historical patterns for guidance.

The semi-strong form holds that prices move quickly in an unbiased manner to incorporate new information, so investors cannot make money trading on news. The strong form states that prices incorporate all relevant information. This structure alone has considerable impact, since the implication is that investors cannot consistently beat the market. That is why efficient capital markets are said to be impossible.