Question

1. Discuss the efficient market hypothesis. To be specific, explain the differences between weak

form, semi-strong form, and strong form efficient market. Which do you believe to be true for

the US equity model and why?

Answer 1

Efficient Market Hypothesis: It is the assumption or hypothesis that the market value of any asset is perfectly rational and adjusted for all information provided about the asset and its related aspects. This means that there are never any long-run deviations of actual price from the price that it should be at because the prices are fluctuating only on the basis of the arrival of new information in the market.

There are 3 categories of efficient markets - Weak, semi-strong and strong. In all 3 of them, no excess returns can be earned in the long run because they adjust accordingly. However, in weak form, prices do not reflect actual markets while in the other 2, prices change and adjust rapidly and in an unbiased fashion. Weak- form of efficiency is the more prevalent market form according to real life scenarios while the strong form is more bookish and utopian and will work only when there strong legal barriers.

The US equity model is a semi-strong efficient form of market because the prices adjust rapidly but are not completely unbiased and everything does not happen immediately but it is not an extremely slow mover and prices do follow trends or patterns.