Strong Form Efficiency

12 Key excerpts on "Strong Form Efficiency"

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  eBook - ePub

  Portfolio Management in Practice, Volume 3

  Equity Portfolio Management

  • (Author)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  strong-form efficient market, security prices fully reflect both public and private information. A market that is strong-form efficient is, by definition, also semi-strong- and weak-form efficient. In the case of a strong-form efficient market, insiders would not be able to earn abnormal returns from trading on the basis of private information. A strong-form efficient market also means that prices reflect all private information, which means that prices reflect everything that the management of a company knows about the financial condition of the company that has not been publicly released. However, this is not likely because of the strong prohibitions against insider trading that are found in most countries. If a market is strong-form efficient, those with insider information cannot earn abnormal returns.

  Researchers test whether a market is strong-form efficient by testing whether investors can earn abnormal profits by trading on nonpublic information. The results of these tests are consistent with the view that securities markets are not strong-form efficient; many studies have found that abnormal profits can be earned when nonpublic information is used.20

  3.4. Implications of the Efficient Market Hypothesis

  The implications of efficient markets to investment managers and analysts are important because they affect the value of securities and how these securities are managed. Several implications can be drawn from the evidence on efficient markets for developed markets:

  • Securities markets are weak-form efficient, and therefore, investors cannot earn abnormal returns by trading on the basis of past trends in price.
  • Securities markets are semi-strong efficient, and therefore, analysts who collect and analyze information must consider whether that information is already reflected in security prices and how any new information affects a security’s value.21
  • Securities markets are not strong-form efficient because securities laws are intended to prevent exploitation of private information.

  3.4.1. Fundamental Analysis

  Fundamental analysis

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  Neoclassical Finance

  • Stephen A. Ross(Author)
  • 2009(Publication Date)
  • Princeton University Press

    (Publisher)

  Definition: Weak Form Efficiency. A market is said to be weak form efficient if S t contains all of the past prices of the asset, that is, if {. . . , p t − 2 , p t − 1 , p t } ∈ S t . Definition: Semi-Strong Form Efficiency. A market is said to be semi-strong form efficient if S t contains all publicly available information, including past prices. Since past prices are publicly available, semi-strong efficiency implies weak form efficiency. In addition, for semi-strong efficiency to hold, the mar-ket information set must include all past volume information as well as all other publicly available information such as government statistics, interest rates and their histories, and all accounting information about companies, such as their earnings and, more generally, their income statements and bal-ance sheets. p r E z S t t t t = + + 1 1 1 *[ ]. p r E z = + 1 1 *[ ], 44 CHAPTER 3 Definition: Strong Form Efficiency. A market is said to be strong form effi-cient if S t contains all information. Strong Form Efficiency requires the information set that determines prices to include not only the publicly available information but also the private in-formation known only to some participants in the market. This means, for ex-ample, that when the foreman of the oil rig looks down and sees the first signs of oil in the exploratory well that the company is drilling, the price jumps on the stock exchange to reflect that information. Well, maybe the market doesn’t react that quickly, but the real question is, who does the foreman call first, his boss or his stock broker? The NA risk-neutral formulation of the theory of efficient markets bypasses some of the earlier controversies on the subject, and has some powerful impli-cations. Proposition 1: If S t denotes the market information set, then the value of any investment strategy that uses an information set A t ⊆ S t , is the value of the current investment.

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  Information Efficiency and Anomalies in Asian Equity Markets

  Theories and evidence

  • Qaiser Munir, Sook Ching Kok, Qaiser Munir, Sook Ching Kok(Authors)
  • 2016(Publication Date)
  • Routledge

    (Publisher)

  The third camp of EMH literature is based on the strong-form tests. We notice that there are fewer studies of strong-form efficiency than of weak form and semi-strong form. The existing studies, however, show that the strong-form tests are important in assessing the profitability of insider information. It is quite usual to conclude that the market is inefficient in the presence of insider profits. For instance, over the period January 1992 through December 1996, Brio, Miguel and Perote (2002) show that in the Spanish stock market insiders earn higher returns when investing with corporate private information but outsiders are unable to obtain such excess profits. Khan and Ikram (2011) found evidence that mutual funds outperformed the market in India over the period 1 April 2000 through 30 April 2010. Thus, it is concluded that the Indian capital market is strong-form inefficient. Differing from the preceding studies, Chau and Vayanos (2008) infer strong-form market efficiency in the presence of monopolistic insiders. They studied a sample from the US stock market which consists of a large-cap stock (Coca-Cola) and a small cap stock (Bairnco). In their findings, as the monopolistic insiders reveal their information quickly, the market approaches continuous trading while insiders’ profits do not converge to zero.

  7.0 Conclusions

  This chapter has discussed the background of equity market informational efficiency, efficient market theories (the theory of efficient capital markets, the theory of random walks), the EMH and its implications, technical analysis, fundamental analysis, and the developing trends in the EMH literature. Our discussion has focused on the intellectual history of the EMH, which enables us to provide a clear picture of the underlying theories and core concepts as well as the research in this field.

  The EMH has a strong foundation, and to date it has remained very important to dictate the behaviour of stock prices. A perfectly efficient market may seem to be unrealistic, as arbitrage activities are constrained by information and transaction costs. In addition, it is possible that insiders’ profits are available in equity markets. This suggests that strong-form efficiency is unlikely to happen. However, recent studies, such as Chau and Vayanos (2008), prove that markets may be close to strong-form efficiency. Such evidence offers new insight into the validity of EMH. Meanwhile, extensive evidence of weak-form and semi-strong-form efficiencies are documented in the literature, which shows that efficiency varies across different equity markets. Not surprisingly, some markets are found to be inefficient either in the weak-form or semi-strong-form sense. Thus, the roles played by technical analysis and fundamental analysis are important. In the presence of market inefficiency, the precision of stock price forecasting will be great, depending on the methods used. Analysts need more advanced methods as markets become more efficient. We notice that there are some new inventions, such as the Suzuki and Ohkura (2016) technical indicator and the Shen and Tzeng (2015) combined soft computing model.

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  Theory And Reality In Financial Economics: Essays Toward A New Political Finance

  Essays Toward a New Political Finance

  • George M Frankfurter(Author)
  • 2007(Publication Date)
  • World Scientific

    (Publisher)

  Right here there is the second paradox of financial economics’ market efficiency, because if mar-kets were weak form efficient, there would not be chartists and other gurus who can tell their clients what to do by looking at historical data. Yet, there is an untold number of statistical studies that show unequivocally the existence of weak form efficiency by studying large volumes of data. These studies show that price relatives behave as Brownian motion. What is All Efficiency? 37 33 According to John Kenneth Galbraith, “free markets” is just a kinder gentler term, because Karl Marx gave a bad name to capitalism. The semi-strong form implies that prices, at any point of time, reflect all publicly available information (such as accounting data, publications in journals, analysts’ forecasts, company announcements, Internet, etc.). I have seen mixed results of tests trying to prove the existence of the semi-strong form. Most instances, it depends on how the data are sliced, what time period they pertain to and what were the intentions of the researcher(s). Finally, the strong form means that prices reflect all information, both published and unpublished, at any given point of time. I have not seen a single statistical test that could prove, convincingly, the existence of the strong form of market efficiency. To the best of my academic experience, only the ultra-orthodox believe in the existence of the strong form of effi-ciency, and those by definition do not need any proof. What these three forms of “efficiency” gave to academia was an aper-ture to shuffle, mine, dredge, sift through, spin and torture data (until they confess) to prove or disprove, statistically, the existence of these forms. Thousands of pages for over three decades have been written, inconclusive at best, a matter of religion at worst, mostly showing no more than meticulous mediocrity.

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  The Efficiency of China's Stock Market

  • Shiguang Ma(Author)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  Roberts (1967) initially distinguished three levels of market efficiency by considering three sets of information reflected in the prices. Later, Fama (1970) reconstructed the framework by creating the famous Efficient Market Hypothesis (EMH). Firstly: weak form efficiency, which implies that the information contained in the past prices of stocks is fully reflected in the current prices of stocks. Secondly: semi-Strong Form Efficiency, which implies that all publicly available information is fully reflected in the current prices of stocks. Thirdly: Strong Form Efficiency, which implies that all information, including historical, public and private information, is fully reflected in the current market prices of stocks. 48 The Efficiency of Chinas Stock Market The information of each successive set is nested cumulatively. Thus, the first set of information includes all the historical information of prices. The second set of information includes all the historical information and all the current public available information. The third set of information includes all the historical information, all the current public information and all privately held information. Thus, if the market is semi-strong form efficient, it must also be weak form efficient. Furthermore, if the market is strong form efficient, it must be weak form efficient and semi-strong form efficient. The graphical association of the three sets of information and three classifications of market efficiency are illustrated in Figure 3.2. Figure 3.2 The classifications of market efficiency in EMH From the trace of market efficient curve ME, it can be seen that a market is a weak form efficient market only when all historical information is available in the market. When all historical and current public information is available in the market, the efficiency of the market crosses into the second level, semi-Strong Form Efficiency.

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  Lecture Notes in Market Microstructure and Trading

  • Peter Joakim Westerholm(Author)
  • 2018(Publication Date)
  • WSPC

    (Publisher)

  I have personally tried to invest money, my client’s and my own, in every single anomaly and predictive result that academics have dreamed up. That includes the strategy of DeBondt and Thaler (that is, sell short individual stocks immediately after one-day increases of more than 5%), the reverse of DeBondt and Thaler which is Jegadeesh and Titman (buy individual stocks after they have decreased by 5%), etc. I have attempted to exploit the so-called year-end anomalies and a whole variety of strategies supposedly documented by academic research. And I have yet to make a nickel on any of these supposed market inefficiencies.

  •Clearly, technical analysis has its share of critics. Warren Buffet was quoted saying, “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.”

  •Most apparent incidences of mispricing seem eliminated by transactions costs. The primary exceptions to weak form market efficiency seem to be the IPO effect, probably the January effect, perhaps the small firm effect, and perhaps the P/E effect.

  •There is little agreement as to why these effects persist or even if the latter two do exist, they are anomalies.

  Semi-Strong Form Efficiency

  •Semi-Strong Form Efficiency tests are concerned with whether security prices reflect all publicly available information.

  •For example, how much time is required for a given type of information to be reflected in security prices? What types of publicly available information might an investor use to generate higher than normal returns?

  •The vast majority of studies of semi-strong form market efficiency suggest that the tested publicly available information and announcements cannot be used by the typical investor to secure significantly higher than normal returns.

  Early Tests

  •Cox [1930] found no evidence that professional stock analysts could outperform the market.

  •Cowles [1933] performed several tests of what was later to be known as the efficient market hypothesis (EMH). He examined the forecasting abilities of 45 professional securities analysis agencies, comparing the returns that might have been generated by professionals’ recommendations to actual returns on the market over the same period.

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  The Complete Guide to Portfolio Construction and Management

  • Lukasz Snopek(Author)
  • 2012(Publication Date)
  • Wiley

    (Publisher)

  4 Event studies can be used to determine different price reactions following the release of information.

  Prices may adjust immediately, thus implying that the market is efficient. However, when the price takes some time (several days or even months) to incorporate the information, this is referred to as under- or overreaction that can be exploited by investors.

  Most studies show that investors react quickly, and that it is illusory to hope to make excess returns by trading on information such as dividend announcements, bonus share issues, stock repurchases, acquisitions, mergers, changes in accounting policies, etc. Nonetheless, some recent results show slow adjustment to events such as earnings announcements.5

  We will examine investors' under- and overreaction to information in more detail at a later stage. At this point, we can assume that all publicly available information is not immediately reflected in prices, implying a certain level of market inefficiency.

  6.3 Strong Form Market Efficiency

  “Finally, a market is strong form efficient if prices incorporate all past, public and private information . In this case, it is impossible to earn returns in excess of the market using insider information.”6

  However, in practice, the existence of insider trading invalidates this form; “abnormal” profits can be generated although this constitutes an illegal practice. Independently of any possibility of insider news, so-called pockets of inefficiency may exist. These take time to be corrected and to return to a situation of market equilibrium and efficiency.

  Furthermore, “information is not a free resource ; it entails acquisition costs that may be high. This is the case for many tools and services used by portfolio managers and traders. So this cost must be included in the definition of efficiency, particularly for testing the strong form. It was Grossman and Stiglitz (1980) who showed that prices should not perfectly reflect information.”7 Thus, “an investment fund, which requires constant information processing, must make a return in excess of the average market return to compensate for the cost of this information. If the fund's return exceeds market return and management costs, the market may then be considered inefficient.”8 Of course, there are fund managers who succeed in beating the market after deduction of transaction costs, but they are unable to do so repeatedly, year after year. While the important role played by luck

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  Banking and Financial Systems in the Arab World

  • P. Molyneux, M. Iqbal(Authors)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Efficiency of the stock market may be reduced when there are imbalances in the distribution of information. When there are differences in the level of information obtained, investors with more information would be able to make gains from the trade. From this perspective, Tobin's informational arbitrage efficiency term can be applied here. Tobin views this as when information is equally distributed across all market participants, the investor cannot make any profit from engaging in trade (of a financial asset). This notion can also be applied to explain the role of information in affecting stock market activity. That is, when information is equally distributed across all stock market investors, they cannot make abnormal profits; investors can only make such profits when they have access to some information that is not known to others. Fama (1970) has utilized the idea of fundamental efficiency to develop hypotheses (weak, semi-strong, and strong form) that assess market efficiency in terms of pricing accuracy. Moreover, Fama's efficient market hypotheses incorporate rational expectations theory to evaluate how information may be used to make abnormal profits. Accordingly, the stock market is efficient when investors cannot make use of historical information (weak form), publicly available information (semi-strong form), and private information (strong form) to make abnormal profits. Therefore, Fama's famous hypotheses 182 Banking and Financial Systems in the Arab World assess how far the stock market reveals information so that the stock prices reflect the fundamentals. It is important that stock markets provide correct price signals for listed firms as stock prices can affect firms' sources of finance. For example, a firm's stock price is the cost at which funds are raised for the expansion of the firm. The higher the price, the cheaper the funds; and the lower the price, the more expensive it is for the firm to attract finance from the primary market.

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  Handbook of Market Risk

  • Christian Szylar(Author)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  lucky.

  An efficient market is defined as a market where there are large numbers of rational, profit maximisers actively competing, with each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants. In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value. (Fama, 1970)

  Fama identified three distinct levels (or “strengths”) at which a market might actually be efficient.

  2.2.1 Strong EMH

  In its strongest form, the EMH says a market is efficient if all information relevant to the value of a share, whether or not generally available to existing or potential investors, is quickly and accurately reflected in the market price. For example, if the current market price is lower than the value justified by some piece of privately held information, the holders of that information will exploit the pricing anomaly by buying the shares. They will continue doing so until this excess demand for the shares has driven the price up to the level supported by their private information. At this point they will have no incentive to continue buying, so they will withdraw from the market and the price will stabilize at this new equilibrium level. This is called the strong-form EMH. It is the most satisfying and compelling form of EMH in a theoretical sense, but it suffers from one big drawback in practice. It is difficult to confirm empirically, because the necessary research would be unlikely to win the cooperation of the relevant section of the financial community—insider dealers.

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  Equity Markets and Portfolio Analysis

  • R. Stafford Johnson(Author)
  • 2014(Publication Date)
  • Bloomberg Press

    (Publisher)

  For example, investors/fundamentalists may be too bullish about an unexpected good earnings announcement, causing the market price to overshoot its equilibrium value. Upon further assessment, the market may correct by slowing purchases or selling, causing the price to move down. During this reassessment period, the volatility of the stock price may increase. Semi-strong-form tests of the EMH do not rule out the possibility that during the assessment period some investors may pay less than the new equilibrium price and thus earn abnormal returns, whereas others may pay more than the equilibrium price and therefore earn returns less than the equilibrium return. Instead, the semi-strong-form tests try to determine if there are enough fundamentalists to ensure that investors, on average, do not earn abnormal returns from trading from events and announcements. As a result, the null hypothesis for the semi-strong-form tests, H ss 0, is: H ss 0 : Investors, on average, cannot earn abnormal returns from trading strategies based on publicly available information. Strong-form tests of the EMH are tests of whether all information—public and private—is fully reflected in the security's price. These tests usually take two forms. One form tries to determine whether or not insiders can earn abnormal returns from their private information. That is, do the officers, managers, engineers, scientists, accountants, and others in the company, as well as those who by the nature of their business are close to the company, have private information that would allow them to earn abnormal returns? In the United States and many other countries, there are security laws that require that insiders list their trades with the SEC. The intent of the laws is to make publicly available trades that are based on privileged information. If these and other laws aimed at inside trading are effective, then a priori we would expect security prices to reflect inside information

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  Evolutionary Finance

  • B. Dowling(Author)
  • 2005(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  2 Strong EMH. It specifies that asset prices fully reflect all information from public and private sources at each and every point in time. Obviously, a Strong EMH interpretation as to the way information is imparted assumes 1 See, for example, Brunnermeier (2001) on the presence of asymmetric information and Hirshleifer and Riley (1992) for the link between information and uncertainty. 2 The term “efficient market hypothesis” was coined by Harry Roberts (1967) but since Robert’s paper was never published, it was Fama’s (1970) discussion that subsequently became renown within finance circles. 10 The “Old” View of Finance 11 no “insider” information is present, that no one investor has monopolistic access to price sensitive information or no one investor has “superior” abil- ity. The obvious applied implication of such a purview is that investors cannot consistently make “above normal” profits from trading with market information – there is little point in trying to “time” the market or actively invest. Prices are assumed to adjust to new information (both private and public) instantaneously. Furthermore, many argue that the Strong EMH belief structure assumes that private information is effectively costless (e.g., Reilly and Brown (1997)) – a point we will elaborate upon in greater detail in Section 2.3. Weak EMH. It assumes that current asset prices reflect only all relevant asset market information. What precisely does this mean? Asset market inform- ation includes historical prices, market-positioning data, rates of return, volatility and so on. Basically, the Weak EMH definition implies that asset prices reflect all information that has already been generated within the mar- ketplace.

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  After Enron

  Improving Corporate Law and Modernising Securities Regulation in Europe and the US

  • John Armour, Joseph A McCahery, John Armour, Joseph A McCahery(Authors)
  • 2006(Publication Date)
  • Hart Publishing

    (Publisher)

  By and large, economic theory—or different sorts of empirical tests—is invoked to justify the further step that the adjustment is rational. As such, mere informational efficiency is not necessarily inconsistent with the view that stock prices can over-or under-react to information. See Lev and deVilliers (1994). 18 A somewhat more realistic appraisal is that markets have a high (but not perfect) degree of efficiency: the residual inefficiency is that which makes it profitable for analysts and other professional investors to stay in business. See Grossman and Stiglitz (1980). and skill to hold that expectation reasonably. The vast majority of us should be passive investors, holding risk-adjusted portfolios designed to seek normal market returns and minimize our trading costs. The EntreMed story—recently explored by two Columbia economists in their field’s leading journal—is but one of many efficiency-defying anomalies that have been unearthed since the late 1970s by finance researchers (Huberman and Regev 2001). 19 There are scores of such anomalies, which have provoked spirited debates as to whether they truly are violations of the EMH, or whether instead there might be some explanation that preserves the validity of the theory. What is impressive in the case against market efficiency is not the strength of any individual claim, but their aggregate weight. As one proponent of market efficiency conceded recently, ‘[t]he weight of paper in academic journals supporting anomalies is now much heavier than the evidence to the contrary’ (Rubenstein 2001: 15). If far from dead, market efficiency is at least more contestable than ever. There are many interesting anomalies. Some of the first doubts about the EMH arose out of observations that stock markets are more volatile and generate more trading volume than the EMH would predict.

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