Question

In: Finance

how does capital market efficiency affect implications for investment performance in general?

how does capital market efficiency affect implications for investment performance in general?

Solutions

Expert Solution

Capital market efficiency is based on the belief that the investors cannot beat the market, as the information available is the market is already reflected in the stock prices.

there ate 3 types of market efficiency':

  • weak form: this form of market efficiency reflects the past volume data and prices in current stock prices.
  • semi strong: this form of market efficiency reflects all available public information.
  • strong form : this form of market efficiency reflects all the available public or private information even the inside information.

It believes that neither fundamental analysis nor technical analysis can help predict the future stock prices a stock prices fallow a random pattern and the asset prices cannot be an indicator of the future prices., hence there is no perfect time to purchase stocks. Investors buy undervalued stocks, hoping that they will sell these stocks when their prices shoot up, but according to the efficient market hypothesis , there is no undervalued stocks a, stocks always trade at their intrinsic value.Investors should expect a normal rate of return form the stocks are neither undervalued nor are they overvalued.If a new information is available market may overeact but adjust gradually. Even if a stock is trading a bit cheaply, its demand increases and its prices rise .

So, we should follow a contrarian strategy to beta the market, do against the market and indulge in active trading to earn super normal profit as sometimes there are stories where people earn abnormal profits even in efficient markets.


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