In an efficient market all the known information is immediately discounted by all the investors
and reflected in the security prices in the market.
According to James Loire:
“Efficiency means the ability of the capital market to function, so that prices of securities react rapidly to new information. Such efficiency will produce prices that are appropriate in terms of current knowledge and investors will less likely to make unwise investments.”
Information must be free and quick to flow.
Bottlenecks and cost are not there.
Taxes have no noticeable impact.
Every investors can borrow on lend at same rate.
Investors are rational.
Market prices are efficient and not sticky.
The Random Walk Hypothesis is a financial theory stating that stock market prices evolve according to a random walk and thus the prices of the stock market cannot be predicted.
Perfectly competitive market.
No individual investor or group can influence it.
All investors have same knowledge.
Stock market discount all the information quickly.
Institutional investors or major fund managers have to follow the market.
The price moves in an independent fashion without undue presence.
Future changes in price will only be as a result of some other new piece of information.
The Efficient Markets Hypothesis (EMH) is made up of three forms:
◦ Weak Form
◦ Semi-strong Form
◦ Strong Form
In this diagram, the circles represent the amount of
information that each form of the EMH includes.
Note that the weak form covers the least amount of
information, and the strong form covers all information.
Also note that each successive form includes the previous ones.
Strong Form
Semi-Strong
Weak Form
All information, public and private
All public information All historical prices and returns
This form of market holds that current prices of stocks fully reflect all historical information, thus past data cannot be used to predict future prices.
Tests of the Weak Form
Serial correlations
Runs tests
Filter rules
The semi strong form states that current prices instantaneously reflect all publicly available information such as quarterly reports, changes in accounting information, dividends, splits etc.
Test of Semi Strong Form
Market Reaction Test
Earning Impact
Secondary Offering Impact
Block Trade Impact
Bonus Impact
The strong form says that prices fully reflect all information, whether publicly available or not.
Even the knowledge of material, non-public information cannot be used to earn superior results.
Most studies have found that the markets are not efficient in this sense.
Test Of Strong Form
Trading By Stock Exchange Officials.
Trading By Mutual Fund Managers.
Markets Have No Memory
Trust Market Prices
Read The Entrails
There Are No Financial Illusions
Do It Yourself Alternative
Seen One Stock, Seen Them All
