Question

Answer in 200 words

Describe the efficient market theory. In your opinion, are the markets efficient? If so, what form of efficiency is present in financial markets?

Answer 1

The efficiency of a market is affected by the number of market participants and depth of analyst coverage, information availability, and limits to trading.The efficient market theory states that stock prices reflect all the available information. No investor can earn an abnormal profit as all past information is already elected in stock prices and neither fundamental  nor technical analysis can help beat the market.

For example : Microsoft announced an earnings increase of 20 percent (a good-news surprise) or an earnings decline of 5 percent (a bad-news surprise), the market would quickly adjust Microsoft’s price in reaction to the unexpected news. Thus it is impossible to earn an extra profit in efficient markets.

When the markets are efficient the intrinsic value and the market value are very close to each other.

The markets are not efficient as with superior stock selection and creating a portfolio of securities in different weightage of the index, a fund manager can generate abnormal returns and beat the market index.

There are three forms of market efficiency:

• weak form
• semi strong form
• strong form

The weak form states that investors cannot earn abnormal profits as past information and volume data is already reflected in the stock prices.

Semi strong form states that stock prices reflect all public information. Semi string form of market efficiency states that stocks quickly reflect all the available information into the stock prices.

Strong form of market efficiency states that stock prices reflect all available and insider information as well.

The markets in reality do not fall under any of these three forms of market efficiency.

In reality, markets  do not fully incorporate information, then opportunities may exist to make a profit from the gathering and processing of information. Market inefficiencies are caused by regulatory structures or behavioral biases.

There are some evidence which  supports the idea that securities markets in developed countries are semi-strong-form efficient; however, empirical evidence does not support the strong form of the efficient market hypothesis.

Hence , we conclude that although in reality market are not really efficient but few studies provide evidence states markets ind developed economies mat be semi -strong form of market efficient.