Question

(Portfolio Management and Sustainability)

What is an efficient market? What dose it imply for investment and valuation models give example?

Answer 1

An Efficient market is a market which reflects that the share price had already discounted all the past publicly available information, as well as privately available information, so there is no scope for any investor to make any extraordinary rate of return, which can beat the index.

Efficient market advocates that there should always be passive investment strategies adopted by investor by following the overall index. they cannot beat the rate of return of index by following active management strategy. There are no arbitraging strategies possible in an efficient market . There are also no insider trading that can happen in an Efficient market and hence there is no probability of any fraud.

It implies for valuation that there is always and rfficient market and there is only reaction for new information. There cannot be any reaction for past performance so if one has to value the stock, it would be helping the stock on forward earnings, because past earnings as well as the earnings which are known by the board and yet to be reported are already discounted into the share price.

Efficient market also nullifies any kind of technical as well as fundamental analysis and it advocates that this kind of analysis are not sustainable in an Efficient market because they can never beat the rate of return of index.

so investors who want to make money out of an Efficient market must follow a passive investment strategy, and they should just replicate the index and they should not be trying to do anything adventurous to beat the market.they will not be prone to any kind of insider trading as well as they will also not be prone to any kind of fraud as the prices already reflect all informations available.