Different Forms Of Market Efficiency

Capital markets provide a function which facilitates the buying and selling of long-term financial securities to increase liquidity and their value, Watson & Head (2013). Hence, the Efficient Market Hypothesis (EMH) explains the relationship that exists with the prices of the capital market securities, where no individual can beat the market by regularly buying securities at a lower price than it should be. This means that in order to be an efficient market prices of securities will have to fairly and fully reflect all available information, Fama (1970). Consequently, Watson & Head (2013) believe that market efficiency refers to the speed and quality of how share price adjusts to new information. Nevertheless, the testing of the efficient markets has led to the recognition of three different forms of efficiency in which explains how information available is used within the market. In this essay, the EMH will be analysed; testing of EMH will show that the model does provide strong evidence to explain share behaviour but also anomalies will be discussed that refutes the EMH. Therefore, a judgment will be made to see which structure explains the efficient market and whether there are some implications with the EMH, as a whole.

DFA’s trading strategy such as avoiding stocks if news announcements are coming in the near future or if stock has recently reported sales by insiders reflect a belief that stock prices can potentially not reflect all private information. DFA also does not accept the weak-form efficient because if stock prices only reflect all information in past prices, they would see the value of performance fundamental analysis of the firm they are looking at (but the case indicates that DFA does not performance fundamental analysis).

It is believed that Efficient Market Theory is based upon some fallacies and it does not provide strong grounds of whatever that it proposes. More importantly the Efficient Market theory is perceived to be too subjective in its definition and details and because of this it is close to impossible to accommodate this theory into a meaningful and explicit financial model that can actually assist investors in making the investment decisions (Andresso-O’Callaghan, B., 2007).

As Chapter 10 questions, if further evidence continues to surface that capital markets do not always behave in accordance with the efficient market hypothesis, then should we reject the research that has embraced the EMH as a fundamental assumption? In this regard we can return to earlier chapters of this book in which we emphasised that theories are abstractions of reality. Capital markets are made of individuals and as such it would not (or perhaps, should not) be surprising to find that the

As our discussion of market efficiency suggested, identifying mispriced securities is not easy. Yet there are enough chinks in the efficient market hypothesis and hence the search for mispriced securities cannot be dismissed out of hand. Moreover, remember that is

The Efficient-Market Hypothesis (EMH) states that it is impossible to beat the market because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information.

Allocating the ownership of economy’s stock capital is the primary role of capital market. In an ideal market the price would provide accurate signals for allocation of resources. Ideal market is one in which firm’s production-investment decisions and investor’s decision regarding securities will depend on the assumption that the security prices fully reflect available information at any point in time. A market in which prices always “fully reflect” available information is called efficient.1

In the efficient market everyone make a decision based on the information they have got. In the real circumstances, there is an agency problem so the agents know more information than the shareholder, so they make high investment and make abnormal profit. This is known as a corporate fraud. If the investors find out about this the fraudulent activity then this cause to stop the investments in particular sector. This lead to decrease share price in particular sector. If the price gone up this means that market is in-efficient.

Another concern relates of insider trading of market efficiency of stock market. In his classical study Fama (1970) proposes efficient market Hypothesis, which suggests that stock price reflects all available information (historical price, public and private) in

Efficient Market Hypothesis has been controversial issues among researcher for decades. Until now, there is no united conclusion whether capital markets are efficiency or not. In 1960s, Fama (1970) believed that market is very efficient despite there are some trivial contradicted tests. Until recently, both empirical and theatrical efficient market hypothesis was being disputed by behavior finance economist. They have found that investor have psychological biases and found evidences that some stocks outperform other stocks. Moreover, there are evidences prove that market are not efficient for instance financial crisis, stock market bubble, and some investor can earn abnormal return which happening regularly in stock markets all over the world. Therefore, the purpose of this essay is to demonstrate that Efficient Market Hypothesis in stock (capital) markets does not exist in the real world by proofing four outstanding unrealistic conditions that make market efficient: information is widely available and cost-free, investor are rational, independent and unbiased, There is no liquidity problem in stock market, and finally stock prices has no pattern.

The weak-form efficiency cannot explain January effect. In semi-strong-form efficient market, to test this hypothesis, researchers look at the adjustment of share prices to public announcements such as earnings and dividend announcements, splits, takeovers and repurchases. As time goes, later tests tend to be not supportive to EMH. For instance, semi-strong-form efficiency cannot explain the pricing/earning effect. In strong-form efficiency, the highest level of market efficiency, Fama (1991) pointed out the immeasurability of market efficiency and suggested that it must be tested jointly with an equilibrium model of expected. However, perfect efficiency is an unrealistic benchmark that is unlikely to hold in practice.

The Weak-form EMH implies that market efficient, reflecting all market information. And the price reflect all past price and volume data. We’re using weak-form EMH in technical analysis by using the past data and historical data. It could not affect the future rates. Empirical evidence supports the weak-form. A strong body of evidence supports weak-form efficiency in the major U.S. securities markets.

Proponents of market efficiency (or academics) would say that technical analysis is a waste of time and cannot result in abnormal profits. This is because in a weak form, semi-strong or strong form efficient market, share prices should have already reflected historical price and volume data, and no-one can earn an abnormal return from strategies based in this information. Thus, we could also say that technical analysts or chartists do not believe in any form of market efficiency.

Market efficiency tests include weak, semi-strong and strong three forms. They assume that financial markets are "informationally efficient", or that prices of trading assets, already reflect all known information and therefore are unbiased in the sense that they reflect the collective beliefs of all investors about future prospects. The weak form test is based on the past information and public available information for semi-strong while strong form covers not only the public but also the private information.

First, when it comes to the importance of efficiency, no one can describe better than the professor Gillian Hadfield, who said that efficiency is the “bedrock of gold ” of the capital market,