IFFM Blog #2: Stock Market Efficiency and Capital Markets
Capital Market is a system in which investors transfer those funds to individuals, companies, and governments that have a need of funds. (saylordotorg.github.io, n.d.) It carries out the desirable economic function of directing and driving funds in form of capital to productive uses. Capital markets can be accessed in either debt or equity.
Market efficiency suggests that at any given time, prices fully reflect all available information on a particular market. For it to become efficient, investors must have the perception that the market is inefficient and possible to beat. (Heakal, 2013)
In 1970, Eugene Fama hypothesised that there are 3 different forms of Market Efficiency (EMH):
1. Weak Form Efficiency
Weak form is when available public information is used, mainly historical data, in attempts to determine the current share prices in the market. (open.edu, n.d.) There is fundamentally no mechanical trading rules based on historical movements which will generate profits in excess of the average market return, unless by chance.
2. Semi-Strong Form Efficiency
Semi-strong form indicates that share prices adjusts to relevant new information by swiftly digesting the data to move the price. (open.edu, n.d.) Share prices reflect all historic and publicly available information. However, abnormal returns cannot be made in this manner as the prices have already been adjusted to reflect the information.
3. Strong Form Efficiency
Strong form suggests that share prices reflect all information, both private and public. In this scenario, no abnormal returns can be made. It is the most satisfying and compelling form of EMH in a theoretical sense, however its drawback is that It is difficult to confirm empirically, as the necessary research would be unlikely to win the cooperation of insider dealers.
EMH seems to suggest that markets are efficient at digesting information which affect prices, and that investors will be able to beat the market. As much as that is true, there are also markets which are still inefficient simply because there are not enough parties to make it efficient. That being said, it has to be taken to consideration that such "other" markets can almost be considered small markets. This simply means that they are not open to profitable exploitation by large number of people. If there were a large number of people, it would just indicate that the markets are not small and thus rendering it not inefficient.
References:
open.edu. (n.d.). 3 The Efficient Markets Hypothesis (EMH). [online] Available at: http://www.open.edu/openlearn/money-management/money/accounting-and-finance/the-financial-markets-context/content-section-3 [Accessed 30 Jan. 2018].
Bergen, J. (2011). Efficient Market Hypothesis: Is The Stock Market Efficient?. [online] Forbes.com. Available at: https://www.forbes.com/sites/investopedia/2011/01/12/efficient-market-hypothesis-is-the-stock-market-efficient/#7bce2c6576a6 [Accessed 30 Jan. 2018].
Heakal, R. (2013). What Is Market Efficiency?. [online] Forbes.com. Available at: https://www.forbes.com/sites/investopedia/2013/11/01/what-is-market-efficiency/#3eb56efe1d2d [Accessed 30 Jan. 2018].
Saylordotorg.github.io. (n.d.). Understanding International Capital Markets. [online] Available at: https://saylordotorg.github.io/text_international-business/s11-02-understanding-international-ca.html [Accessed 30 Jan. 2018].
Market efficiency suggests that at any given time, prices fully reflect all available information on a particular market. For it to become efficient, investors must have the perception that the market is inefficient and possible to beat. (Heakal, 2013)
In 1970, Eugene Fama hypothesised that there are 3 different forms of Market Efficiency (EMH):
1. Weak Form Efficiency
Weak form is when available public information is used, mainly historical data, in attempts to determine the current share prices in the market. (open.edu, n.d.) There is fundamentally no mechanical trading rules based on historical movements which will generate profits in excess of the average market return, unless by chance.
2. Semi-Strong Form Efficiency
Semi-strong form indicates that share prices adjusts to relevant new information by swiftly digesting the data to move the price. (open.edu, n.d.) Share prices reflect all historic and publicly available information. However, abnormal returns cannot be made in this manner as the prices have already been adjusted to reflect the information.
3. Strong Form Efficiency
Strong form suggests that share prices reflect all information, both private and public. In this scenario, no abnormal returns can be made. It is the most satisfying and compelling form of EMH in a theoretical sense, however its drawback is that It is difficult to confirm empirically, as the necessary research would be unlikely to win the cooperation of insider dealers.
(Figure 1. Relation of 3 Forms of EMH
EMH seems to suggest that markets are efficient at digesting information which affect prices, and that investors will be able to beat the market. As much as that is true, there are also markets which are still inefficient simply because there are not enough parties to make it efficient. That being said, it has to be taken to consideration that such "other" markets can almost be considered small markets. This simply means that they are not open to profitable exploitation by large number of people. If there were a large number of people, it would just indicate that the markets are not small and thus rendering it not inefficient.
References:
open.edu. (n.d.). 3 The Efficient Markets Hypothesis (EMH). [online] Available at: http://www.open.edu/openlearn/money-management/money/accounting-and-finance/the-financial-markets-context/content-section-3 [Accessed 30 Jan. 2018].
Bergen, J. (2011). Efficient Market Hypothesis: Is The Stock Market Efficient?. [online] Forbes.com. Available at: https://www.forbes.com/sites/investopedia/2011/01/12/efficient-market-hypothesis-is-the-stock-market-efficient/#7bce2c6576a6 [Accessed 30 Jan. 2018].
Heakal, R. (2013). What Is Market Efficiency?. [online] Forbes.com. Available at: https://www.forbes.com/sites/investopedia/2013/11/01/what-is-market-efficiency/#3eb56efe1d2d [Accessed 30 Jan. 2018].
Saylordotorg.github.io. (n.d.). Understanding International Capital Markets. [online] Available at: https://saylordotorg.github.io/text_international-business/s11-02-understanding-international-ca.html [Accessed 30 Jan. 2018].
Comments
Post a Comment