Question

Discuss the three forms of the efficient market hypothesis. What is the security market line?

Answer 1

Three forms of the efficient market hypothesis.

Weak form : Weak form efficiency is one of the three different degrees of efficient market hypothesis (EMH); it claims that past price movements and volume data do not affect stock prices. As weak form efficiency is theoretical in nature, advocates assert that fundamental analysis can be used to identify undervalued and overvalued stocks. Therefore, keen investors looking for profitable companies can earn profits by researching financial statements.

Strong Form : trong form efficiency is the strongest version of market efficiency and states that all information in a market, whether public or private, is accounted for in a stock's price. Practitioners of strong form efficiency believe that not even insider information can give an investor an advantage. This degree of market efficiency implies that profits exceeding normal returns cannot be made, regardless of the amount of research or information investors have access to.

Semi strong : Semi-strong form efficiency is a class of EMH (Efficient Market Hypothesis) that implies all public information is calculated into a stock's current share price, meaning neither fundamental nor technical analysis can be used to achieve superior gains. This class of EMH suggests only information not publicly available can benefit investors seeking to earn abnormal returns on investments. All other information is accounted for in the stock's price and no amount of fundamental or technical analysis achieves superior returns.

What is the security market line?

The security market line (SML) is a line drawn on a chart that serves as a graphical representation of the capitalasset pricing model (CAPM), which shows different levels of systematic, or market, risk of various marketablesecurities plotted against the expected return of the entiremarket at a given point in time.