MARKET EFFICIENCY There are two types of efficiency exits in the market. 1. Operational Efficiency 2.

Informational Efficiency Operational Efficiency: Transaction must be executed within a very short period time & the cost of transaction will be as low as possible. Informational Efficiency: Our major concern is Informational efficiency. A market would be called efficient if security prices reflect all available information. If information is reflected in the price very quickly and accurately then the market will be called efficient. This information is price sensitive information. Price sensitive information: Information that might change the price. Exampleo Dividend declared o Earnings of firms o Change in Interest rate o Change in the scenario of Export & Import o Change in Inflation etc. There are two form of market efficiency 1. Weak Form of Efficiency 2. Semi-strong Form of Efficiency 3. Strong Form of Efficiency 1. Weak Form of Efficiency:
In a weak-form efficient market, it is impossible to predict future returns. One of the different degrees of efficient market hypothesis (EMH) that claims all past prices of a stock are reflected in today's stock price. If security price reflect all information

contained in the history of its own prices and volume data. Past stock price is publicly available and virtually costless to obtain. The weak form of efficiency holds that if such data are ever conveyed reliable signals about future performance, all investors already would have learned to exploit the signal. Ultimately signal loss their value as they become widely known because a buy signal would result in an immediate price increase. *Nobody will earn abnormal return * Trend analysis is fruitless. * In case of weak form people who will be sufferer is technical analysts. (Share Price=SP, Volume=V) o SP↓--V↑-- negative-- Sales motivation transaction o SP↑--V↓--Positive—Purchase motivation transaction o SP↓↑--V is constant—One investors bought large volume

1

earnings forecasts and accounting practices. Past information is reflecting present but this past info can’t be used to reflect future. Again. Series of past dividend 2 . Semi-strong form of Efficiency Market will be called semi-strong form of efficient if security’s prices reflect all publicly available information. *If market is semi-strong form of efficient then fundamental analysis is worthless * Fundamental analysis= what is its capacity to generate cash flow.Expected return Actual return >Expected return = Positive Abnormal return Actual return < Expected return = Negative Abnormal return AR= rt – E(Vt) here rt = Actual Return = Vt-[rft+ß rmt] A category = Last year return was 10% B category = 5% Z category = No dividend G category= Green field Strong Looser Winner Weak Semi-Strong Form For good info For bad info 2. balance sheet composition. Such information includes past prices as well as fundamental data on the firm’s product line. if investors have access to such information from publicly available sources. one would expect it to be reflected in stock price.      Every successive price change should be random. quality of management. Abnormal return= Actual return.

* If the market is strong form of efficient. *Investors have access to info that the managers in different department know. The turn of the year effect (January effect) January effect is tied to tax loss selling at the end of the year. The strongest version of market efficiency. See also efficient market. random selection is as good as any other sophisticated selection. Strong form of Efficiency A market will be called strong form of efficient if security’s prices reflect all info both public & private. 3 . Many people sell stocks that have declined in price during the previous months to realize their capital losses before the end of tax year. is accounted for in a stock price. Anomalies 1. Not even insider information could give an investor the advantage. Size Effect: Abnormal rate of portfolio is large --Risk adjusted average return of on the small stock portfolio is (+)ve 4. This situation can be true only when financial market regulators have the power to prohibit and punish the use of insider information. Nominal rate< return---People can earn 2. Market to book ratio: The firm who’s M to B ratio is higher investing those will help to generate abnormal return↑ Strong-efficient market (See Chapter 15 of the Vernimmen) In a strong-efficient financial market. investors with privileged or insider information or with a monopoly on certain information are unable to influence prices of securities. It states all information in a market. Such investors do not put the proceeds from these sales back into stock market until after the turn of the year.Event study helps to say whether the market is efficient or inefficient. Day of the weak effect (At the time of Christmas SP↓ and after that SP↑) 3. Debt ratio --If you invest in leveraged firm then you will earn (+)ve return 5. Test 1st = speed at which new info reflect in security price 2nd = How accurate is the price after coming the info *SUE= Standardized unexpected earning Et − E ( E t ) > 0 = (Good news) Investors are presently surprised as Sp is above their expectation σE Et − E ( E t ) < 0 = (Bad news) Investors see that Sp is below their expectation σE 3. whether public or private.

Theoretical in nature. Weak-form efficient market (See Chapter 15 of the Vernimmen) In a weak-form efficient market. or improving the look of the accounts by adjusting exceptional items. etc.This degree of market efficiency implies that profits exceeding normal returns cannot be made. technical analysis cannot be used to predict and beat a market. One of the different degrees of efficient market hypothesis (EMH) that claims all past prices of a stock are reflected in today's stock price. weak form efficiency advocates assert that fundamental analysis can be used to identify stocks that are undervalued and overvalued. Therefore. Existing prices already reflect all the information that can be gleaned from studying past prices and trading volumes. interest rates and returns. 4 . regardless of the amount of research or information investors have access to. keen investors looking for profitable companies can earn profits by researching financial statements. provisions. it is impossible to predict future returns. Therefore. Window dressing (See Chapter 19 of the Vernimmen) The practice of massaging EPS is called "window dressing".

Sign up to vote on this title
UsefulNot useful