Market Efficiency

10 Key excerpts on "Market Efficiency"

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  eBook - ePub

  Understanding Investments

  Theories and Strategies

  • Nikiforos T. Laopodis(Author)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  Since the 2008/9 Great Recession, a number of market analysts have suggested that individual investors should not try to time the market or pick stocks based on past performance, or even conduct fundamental analysis, but instead they should invest in stock index funds. This recommendation is based on a belief that Market Efficiency is reflected in stock and other asset prices as well as indexes. In addition, with the widespread use of technology (for sharing of information on social media with devices like smartphones), markets have become even more efficient, because new information arrives more rapidly and disseminates widely and thus levels the trading field for all.

  Now, let us turn to the three different forms of Market Efficiency to see how efficient the stock market is.

  9.2.2 The forms of Market Efficiency

  Investors look for pricing inefficiencies because these would open up profit opportunities. Such profit opportunities in investment assets can be categorized into three forms of pricing efficiency based on the amount of all available information investors have and use in their asset valuations. All three forms imply that excess profits can be made only by chance (or luck) and unrelated to available (public or private) information.

  Weak form

  This type of Market Efficiency assumes that an investor cannot earn excess profits by using all past information on an asset because that information is already reflected in the current price of the asset. Thus any historical market data (price and trading volume) on the asset are incorporated into the current price of the asset and should have no value in predicting the asset’s price in the future. Past data are now part of public information and useless. If such data in the past had any profit value, then that value would have been exploited at that time and no significant residual value would remain in the present.

  Semi-strong form

  The semi-strong type of Market Efficiency states that, in addition to all past information, all currently publicly available information should already be reflected in the current price of the asset. Some examples of such public information on a firm would be its earnings forecasts, quality of management, financing status, and the like. The instant such information is released in the market the asset’s prices should immediately adjust to reflect that information. Such information can be obtained either from the firms’ webpages (for free) or from your broker (for a fee). Therefore, if all investors can access that information, then no one should be able to make abnormal profits.

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  Financial Management from an Emerging Market Perspective

  • Guray Kucukkocaoglu, Soner Gokten, Guray Kucukkocaoglu, Soner Gokten(Authors)
  • 2018(Publication Date)
  • IntechOpen

    (Publisher)

  Introduction One of the most common issues for investors regarding markets nowadays is to what extent these markets are efficient as all of them aim to increase their gains and beat the market as much as possible. But what do we mean by ‘efficiency’? The term ‘efficiency’ is used in many different contexts with different meanings. If we look at the productivity side, efficiency is © 2018 The Author(s). Licensee InTech. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. used to refer to a situation where the quantity produced is at such a level that the more you produce from this point onwards it will lead to a fewer productions of the other. In a similar context, one can also think of Pareto efficiency: distribution or resources to make one better off but at the expense of another [ 1 ]. When analysing financial markets, whether these markets are from a developed or from an emerging economy, the term ‘efficiency’ refers to the informational efficiency of the market, which is about the degree of information reflected in the prices of financial assets [2]. It reflects how the financial asset prices adapt to the incoming information. The quicker it reflects the more informational efficient the market will be, making it hard for these investors to beat the market [ 3 , 4]. In this chapter, we will be explaining the efficient market hypothesis (EMH), which is the main theory behind information efficiency; relevant definitions will be given and the dif -ferent forms of efficiencies will be identified using previous studies.

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  Investments

  Principles of Portfolio and Equity Analysis

  • Michael McMillan, Jerald E. Pinto, Wendy L. Pirie, Gerhard Van de Venter(Authors)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  2 Informative prices thus promote economic growth. The efficiency of a country’s capital markets (in which businesses raise financing) is an important characteristic of a well-functioning financial system.

  The remainder of this chapter is organized as follows. Section 2 provides specifics on how the efficiency of an asset market is described and discusses the factors affecting (i.e., contributing to and impeding) Market Efficiency. Section 3 presents an influential three-way classification of the efficiency of security markets and discusses its implications for fundamental analysis, technical analysis, and portfolio management. Section 4 presents several market anomalies (apparent market inefficiencies that have received enough attention to be individually identified and named) and describes how these anomalies relate to investment strategies. Section 5 introduces behavioral finance and how that field of study relates to Market Efficiency. Section 6 concludes and provides a summary.

  2. THE CONCEPT OF Market Efficiency 2.1. The Description of Efficient Markets

  An informationally efficient market (an efficient market ) is a market in which asset prices reflect new information quickly and rationally. An efficient market is thus a market in which asset prices reflect all past and present information.3

  In this section we expand on this definition by clarifying the time frame required for an asset’s price to incorporate information as well as describing the elements of information releases assumed under Market Efficiency. We discuss the difference between market value and intrinsic value and illustrate how inefficiencies or discrepancies between these values can provide profitable opportunities for active investment. As financial markets are generally not considered being either completely efficient or inefficient, but rather falling within a range between the two extremes, we describe a number of factors that contribute to and impede the degree of efficiency of a financial market. Finally, we conclude our overview of Market Efficiency by illustrating how the costs incurred by traders in identifying and exploiting possible market inefficiencies affect how we interpret Market Efficiency.

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  Neoclassical Finance

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

    (Publisher)

  THREE EFFICIENT MARKETS E FFICIENCY IS ONE of those words that is so appealing that we use it to describe many different phenomena. To an economist efficiency usually means “Pareto efficiency,” which is a state of affairs where no individ-ual’s position can be improved without impairing another’s, or “productive effi-ciency,” which occurs when output cannot be increased for any one desirable good without lessening the production of another. In finance we refer to a mar-ket as efficient if it is informationally efficient. This is interpreted as saying that market prices incorporate all of the relevant information. Exactly what is meant by this attractive phrase is not entirely clear—nor is its relation to the other definitions of efficiency immediately apparent—but, roughly speaking, it is in-tended to convey the idea that since prices are the result of the decisions of in-dividual agents, prices should therefore depend upon the information underlying those decisions. As a corollary, it should not be possible to attain superior returns by using the same information that the market possesses. Furthermore, it implies that the future returns on assets will largely depend not on the information cur-rently possessed by the market but, rather, on new information that comes to the market, that is, on news. An investor whose information is the same or inferior to the information already incorporated into the prices will have no ability to predict the news and, therefore, no ability to outperform the market. Pertinent to these issues, there is a large and fascinating literature on what is referred to as the No-Trade Theorem (see, e.g., Milgrom and Stokey 1982 or Tirole 1982).

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  The Efficiency of China's Stock Market

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

    (Publisher)

  However, external efficiency relates to the outside influences on the market. Of those influences, information has the greatest effect on pricing. Usually, following the release of information, the share prices are adjusted up or down, and share returns rise and fall. The prices of shares act as signals for capital allocation into the most productive sectors. Therefore, external efficiency pertains to price efficiency, or in other words, informational efficiency relates to the impact of information on market prices. The core of the efficient market theory is about ‘what’ ‘when’ and ‘how’ information is used to determine prices on the markets. Definition of an efficient stock market As Fama (1970) explained, a perfectly efficient stock market is a market in which the prices of stocks fully reflect all available information at any time. Suppose that a stock market is efficient with respect to an information set cp. Every participant of the market can access the information set cp, and trade shares on the basis of cp. Then the information is incorporated totally into the prices, and every share price is adjusted to be equal to its (investment) market value (Sharpe 1985). Therefore, no one can monopolise information to gain a comparative advantage over others, and no one can discover a regular pattern to get abnormally high profits. An efficient market requires that prices react to new information instantaneously. In practice this means that when new information becomes available in the market, it should be fully reflected in the prices immediately. The prices should be updated to a new equilibrium level by the new information. If the market processes the new information slowly, i.e., the prices do not react to the new information instantaneously; there will exist a trading rule allowing some share traders to generate abnormally high profits.

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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)

  36 Theory and Reality in Financial Economics This notion, lately, found for itself several new euphemisms for the ben-efit of the common man, the most popular of which are “free markets,” 33 “globalization,” “new/space age,” “the new world order,” etc. Tinkering with markets, such as government regulations, means imposing inefficiencies — the bane of society. Thus, Market Efficiency is a moral view of the world and everyone should subscribe to this view. I would like to emphasize the adjective moral, because there is a social policy hiding behind this theory of mar-ket efficiency. First, the notion that it is best for society to leave the mar-ket alone (do not regulate). And second, that everything which is done for the best interest of the shareholders of corporations is in the best interest of society as a whole as well. Of course, those who are not shareholders (roughly 50% of the popu-lation in the US and a much higher percentage in Europe, or elsewhere) may take issue with this worldview, but in the big scheme of things they do not count (they do not vote, either). Later, and it is not clear to me how and by whom, although I made an honest effort to discover it, three subcategories of informational efficiency were suggested: • Weak; • Semi-strong; • Strong. The weak form means that one cannot obtain information that would put one in advantage from tracking the history of price movements. If this form of efficiency were true, it would be tantamount to sending financial analysts, called chartists, to the unemployment line, because they sell, and for a good price too, worthless advice to the public. 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.

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  The Economics of Financial Markets

  • Roy E. Bailey(Author)
  • 2005(Publication Date)
  • Cambridge University Press

    (Publisher)

  Market Efficiency is then interpreted as an absolute characteristic – an absolute that is never attained in practice. Very little is known about relative efficiency. Much more research is needed before any confident inferences can be made, both about whether the concept is itself interesting and, if so, about the outcome of comparisons made according to any given set of efficiency criteria. Summary Tests of efficiency cannot be separated from the models and the information sets on which their predictions are conditioned. Appearances can deceive; a test of efficiency is not model-free merely because the model is left implicit . This does not mean that tests of efficiency are impossible or worthless. It does mean that the conclusions about efficiency must be conditional on the model that provides the criteria for efficiency – the conclusions can never be incontrovertible. Hence, the bold question ‘are financial markets efficient?’ is, at best, a rhetorical device to initiate debate. Unequivocal answers deserve to be treated with the utmost suspicion. Predictability of prices and Market Efficiency 69 3.2.3 Beating the market Informational efficiency is often defined in terms of the profits that could be made by exploiting information: ‘A market is efficient with respect to a particular set of information if it is impossible to make abnormal profits (other than by chance) by using this set of information to formulate buying and selling decisions’ (Sharpe, Alexander and Bailey, 1999, p. 93). Similarly: ‘ efficiency with respect to an information set, , implies that it is impossible to make economic profits by trading on the basis of ’ ( New Palgrave Dictionary of Money and Finance , Newman, Milgate and Eatwell, 1992, Vol. I, p. 739; the symbol denotes the same set as the t used here). In the quotations, ‘abnormal profits’ and ‘economic profits’ (both can be under-stood to mean the same thing) must be determined according to some criterion or another.

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  Stock Markets in Islamic Countries

  An Inquiry into Volatility, Efficiency and Integration

  • Shaista Arshad(Author)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants…’. Other definitions of Market Efficiency were given by Jensen (1978), who states, ‘A market is efficient with respect to information set O t if it is impossible to make economic profits by trading on the basis of informa- tion set O t ’. Malkiel (1992) (Efficient Market Hypothesis, New Palgrave Dictionary of Money and Finance) provided a rather similar definition: A capital market is said to be efficient if it fully and correctly reflects all relevant information in determining security prices. Formally, the market is said to be efficient with respect to some information set, Xt, if security prices would be unaffected by revealing that information to all participants. Moreover, efficiency with respect to an information set, O t , implies that it is impossible to make economic profits by trading on the basis of O t . The underlying concept of EMH was first introduced by Samuelson (1965) who in his seminal paper birthed the idea through his interest in temporal pricing models of storable commodities that are harvested and subjected to decay. Samuelson noted that if a market is informationally efficient, any changes in price, if properly anticipated, should be unfor- ecastable. In other words, the prices would include all the information and expectations of all market participants. Fama’s approach to the EMH is summarized in the axiom ‘prices fully reflect all available information’. The hypothesis finds its basis in the random walk hypothesis (RWH) and martingale model, which are two statistical descriptions of unforeca- stable changes in price (Blume and Durlauf 2007). Primarily, the logic behind the RWH relies on the fact that the flow of information is uncon- strained and will be reflected immediately in stock prices.

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  eBook - ePub

  Micro Markets Workbook

  A Market Structure Approach to Microeconomic Analysis

  • Robert A. Schwartz, Michael G. Carew, Tatiana Maksimenko(Authors)
  • 2010(Publication Date)
  • Wiley

    (Publisher)

  CHAPTER 7

  Market Efficiency

  LEARNING OBJECTIVES

  • Understand the concept of allocation efficiency. Given that economics can be defined as “the study of the optimal allocation of scarce resources among competing needs,” you should not be surprised that the efficiency of resource allocation is of fundamental importance. This chapter focuses on the ability of a market to achieve allocation efficiency (goods and services being produced in the right ways and amounts and consumed in the right amounts from a public policy point of view).

  • Comprehend the meaning of the term market failure. It is important to recognize that a micro market can fail to deliver the allocation efficiency that one might desire from a public policy point of view (and that in extreme cases, a micro market may even fail to exist). Chapter 7 enumerates 10 classic causes of market failure.

  • Understand the link between information and expectations. In an environment characterized by risk and uncertainty, information is the input that participants base their expectations on. Different participants may form identical expectations (referred to as homogeneous expectations) or have different expectations (referred to as divergent expectations). You should recognize the complexity of information, and be aware that our insights into the workings of a financial market are influenced by whether we assume that participants’ expectations are homogeneous, or that they are divergent.

  • Acquire some basic information about information. A sizable part of this chapter focuses on information that you should see as a driving force for the micro markets. In light of its importance, we consider information a factor of production. The chapter states that “information sets themselves can be enormous, incomplete, imprecise, and inaccurate, and inefficiency in the micro markets can, to no inconsequential extent, be attributed to information-related inefficiencies.” An important learning objective is to understand what this entails in greater detail.

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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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