Question

A stock market analyst is able to identify incorrect stock prices by comparing the average price for the last five days to the average price for the last 20 days. If this is true, what do you know about market efficiency? Explain.

Answer 1

Ans) Market efficiency signifies how quickly and accurately does the relevant information have its effect on the asset prices.In other words we can say that depending upon the degree of efficiency of a market , the return earned by an investor will vary from the normal return.Hence if the market is efficient as described in Efficient market hypothesis which states that the successive absolute price changes are independent in the short run. This means that investors are rational and take decisions based on risk and return. There is less scope of abnormal gain .Hence by comapring the average of 5 days stock prices with the previous average of 20 days price , if the stock analyst finds incorrect stock price than this can be a case of Weak form of market efficiency as per the Efficient market Hypothesis , which states that the price information contained in the stock contains all the security market data in other words all the technical analysis information has been covered in the stock price but it does not include the publicly available information like company statements and news article etc and there can be a possibility of insider information.Hence the market efficiency is weak as per the Efficient market hypothesis for the above mention case.