What are the conditions for stock market efficiency?
Is it possible that the market for
individual stocks could be highly efficient, but the market for whole companies could be less efficient? Market efficiency refers to the degree to which market prices reflect all available, relevant information. If markets are efficient, then all information is already incorporated into prices, and so there is no way to "beat" the market because there are no undervalued or overvalued securities available Market efficiency refers to how well current prices reflect all available, relevant information about the actual value of the underlying assets. A truly efficient market eliminates the possibility of beating the market, because any information available to any trader is already incorporated into the market price. As the quality and amount of information increases, the market becomes more efficient reducing opportunities for arbitrage and above market returns. There are three degrees of market efficiency 1. Weak Form: The weak form of market efficiency is that past price movements are not useful for predicting future prices. If all available, relevant information is incorporated into current prices, then any information relevant information that can be gleaned from past prices is already incorporated into current prices. Therefore future price changes can only be the result of new information becoming available. 2. Semi Strong Form: The semi-strong form of market efficiency assumes that stocks adjust quickly to absorb new public information so that an investor cannot benefit over and above the market by trading on that new information. This implies that neither technical analysis nor fundamental analysis would be reliable strategies to achieve superior returns, because any information gained through fundamental analysis will already be available and thus already incorporated into current prices. 3. Strong Form: The strong form of market efficiency says that market prices reflect all information both public and private, building on and incorporating the weak form and the semi-strong form. Given the assumption that stock prices reflect all information (public as well as private), no investor, including a corporate insider, would be able to profit above the average investor even if he were privy to new insider information. Markets are more efficient for individual stocks than for entire companies, so for investors with enough capital, it does make sense to seek out badly managed companies that can be acquired and approved.