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Capital Markets
Definition: Efficient Capital Markets
• In an efficient capital market, security prices
adjust rapidly to the arrival of new information,
therefore the current prices of securities reflect
all information about the security
• Whether markets are efficient has been
extensively researched and remains
controversial
Why Should Capital Markets
Be Efficient?
The assumptions of an efficient market
– 1. A large number of competing profit-maximizing
participants analyze and value securities, each independently
of the others
– 2. New information regarding securities comes to the market
in a random fashion, new information is not predictable.
– 3. Profit-maximizing investors adjust security prices rapidly
to reflect the effect of new information
Conclusion: random unpredictable information + large
competing investors react to news ➔➔➔
Two implications in efficient market
• Pt = E(Pt | Qt-1) + et
– Where Qt-1 is the last-period information set
including earnings news, economic announcements,
industry news, currency news, international news etc.
et reflects randomness as well as any current period
price information
– Thus stock price changes to be independent and
random
Efficient Market Hypotheses (EMH)