Do equity markets completely conform to a "textbook definition" of informational efficiency all the time? Provide...

Do equity markets completely conform to a "textbook definition" of informational efficiency all the time? Provide at least two examples that would be considered anomalies from the standpoint of the efficient markets hypothesis, explaining briefly why they are “inefficient.”

Solutions

Expert Solution

As per EMH, no investor can earn a return in excess of the market because security prices reflect all information, and securities are always perfectly priced.

No, equity markets do not conform to a "textbook definition" of informational efficiency all the time.

Two examples of market anomalies are :

Small firm effect - Historically, stocks of small firms have consistently outperformed large firms. This is "inefficient" because an investor could hold stocks of small firms over a long period to "beat" the return of the overall market.
Market--to-book ratio effect - Historically, it has been the case that stocks of firms with low market-to-book ratios tend to outperform stocks of firms with high market-to-book ratios. This is "inefficient" because an investor could, over the long-term, hold stocks of firms with low market-to-book ratios to "beat" the return of the overall market.

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