Question

Critically explore the concept of efficient markets and discuss to what extent financial markets such as the equity and foreign exchange markets are informationally efficient. Support the answer with relevant examples.

Answer 1

Efficient market theory is a theory which depicts the degree of efficiency of the market. It is a kind of market hypothesis that advocates that market discounts all kind of past as well as present informations and there are no information asymmetry as all the news have already been discounted into the share price.

Efficient market hypothesis advocates that the market has discounted all the public as well as the private information available and there are no room for any extraordinary growth in share price through data analysis.efficient market hypothesis advocates that nobody can outperform the index as index is completely updated with each and every information that has either been public or private so it basically advocates in passive idea of investing.

There are three forms of efficiency in the market. The first one has been advocated as strong form of market efficiency which is described as the market already discounts all public as well as the private informations and hence it can never be out performed by any person. one can only generate the highest degree of return by following the index so one can generate the maximum rate of return through index investing,as it is completely passive form.

Weak form of efficient market advocates that historical values, Trend, and past information cannot predict the future moment of the price of a share. It advocates that market only reflects all current information hence it believes on the fact that it can be out performed on the basis of technical Analysis.

Semi efficient form of market efficiency reflects that all public informations have already been discounted into the price while private information are not discounted into the price yet, so market can only be outperformed through insider trading because the private informations are yet to be discounted into the price.

I personally feel that exchange markets as well as equity markets reflects semiefficient as well as weak form of market efficiency since a lot of active investors have beaten the index rate of returns and semi market efficiency can be reflected through movement in share prices due to insider news because management and the people related to management are already aware of it.