Question

Do you believe that global markets are efficient or inefficient or some combination? Defend your position.

Answer 1

In my opinion, the world markets are combination of both efficient as well as inefficient.

According to Efficient Market Hypothesis(EMH), the market reflects all the available information and the asset prices will adjust automatically as and when the new information comes into market. It states that all the investors have the same information and they use it efficiently while participating in the market. This theory states that the markets are efficient. However, there are many flaws in this theory. The first flaw is that all the investors having the same information does not mean that all the investors would use the information with equal efficiency. Another major flaw is that the human emotions are very crucial in markets. Efficient Market Hypothesis ignores this crucial aspect. So, we can say that the markets are efficient up to some extent, but not fully efficient.

According to EMH proponents, it is very difficult for the investors to beat the market, i.e. it is very difficult to earn abnormal profits. This statement is true. But the reason given by EMH proponents is flawed and it does not justify the statement in real world scenario. The reason stated by EMH is that the prices reflect all the information instantaneously. Although this statement is correct up to some extent, this is not the only reason. The main reason is the human emotions. It is very difficult to quantify these emotions. Emotions influence the prices of assets in the market. Sometimes the human emotions cause the prices to go up drastically with in less time without proper logic behind that. This kind of situation is called market bubble. Sometimes these emotions cause the asset prices plunge drastically with in less time without proper logic behind that. This kind of situation is called market panics. Some say it as bubble has burst.

If EMH has been absolutely true, then the investors would not have been making lot of money or abnormal profits. We would not have come across people like Warren Buffet. In our daily life we come across many investors who make abnormal profits in the financial markets. The reason is that they use the information efficiently and they are more knowledgeable. These investors can make money during asset crashes and asset bubbles as well. The fact is that many investors are irrational in the market.

The new information coming into the market affects the markets in two ways. The information can be good or bad. The good news and the bad news affect the markets in different ways. The same amount of bad news affects the market more than the same amount of good news. For example, if a particular company announces its profits in third quarter as $100mn, then the share price of that company may go up by 3%. In another case, if the same company announces its losses in fourth quarter as $100mn, then the share price of that company may go down by 5%. Here the main reason is the emotions of investors. There is no logic behind this. So, the emotions of investors play a crucial role in deciding whether a market is efficient or inefficient, not just the fundamentals of the market. So, the world markets are efficient as well as inefficient, the markets are combination of both.