Question

In: Finance

Why is it difficult to make excess profits consistently in the efficient capital market?

Why is it difficult to make excess profits consistently in the efficient capital market?

Solutions

Expert Solution

This is because:

  • In an efficient capital market, the stock price is a reflection of all the information about the stock. All the information about the stock is already factored in while market prices it.
  • Prices change only when new information comes in public domain
  • In efficient market, information disclosure is full, timely and complete
  • And market is efficient enough to absorb the new information and quickly adjust the stock price.

Because of these reasons, there is hardly (or at least theoretically) any potential left for the stock price to grow. A stock price jumps or gives excessive return only when there is lack of information or information asymmetry. When everyone in the market has a full access to the same set of information about a stock, then everyone's assessment of the stock is same. Hence, there are very few instances of excess return or growth. Hence, one can't make excessive growth (return) and that also consistently in the efficient market.


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