Market than the market this is because the

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Market than the market this is because the

Market Efficency

What
is Market Efficiency?

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Market efficiency is when stock prices and
other security prices reflect all available information about goods in the
market. This information is pre-assumed to include; the amount of capital used
to produce and supply a certain commodity in the market. Disclosing all the
information about a particular product in the stock market is not advisable
since investors may find loopholes to exploit the stock exchange market (Heakal,
2013). Market
efficiency was first established by an economist named Eugene Fama who had a
theory, that for investors it is not possible to perform better than the market
this is because the stock prices has already got all the information stored
into the price. This
theory was called the Efficient Market Hypothesis, In other words, a
competitive market automatically achieves an efficient allocation of resources
by ensuring equilibrium of demand price with that of supply price and quantity
demand and quantity supply is obtained. With this equilibrium in place, buyers
and sellers have no other option but to seek a mutually exchangeable plan at
the market price that achieves efficiency and maintain competition through
elimination of market failures (Heakal, 2017).

Impact
of Market Efficiency

The direct impact of market efficiency is the
ability to reduce chances of predictability of stock exchange market by
investors. How the stock market is performing, is not limited to financial
reports alone but can also be affected by the political, social and economic
activities of a certain country. Prices respond only to issues which are available
in the market, and since all investors depend on the same information, no one
will have the ability to make profit more than the other investors. In inefficient
markets, the price of goods is random, and investors are limited to plan on how
to exploit the market. This unpredictable nature of the market is referred as the
random walk of prices and is seen as a killer of any investment strategy by
investors who aim to outperform the market. However, the unpredictable nature
of the market has received critics from investors since some investors are
found to have made a profit at the expense of others (Spaulding,
2017).

The
Three Forms of Efficient Market Hypothesis

There are three defining forms of the Efficient
Market Hypothesis: weak-form,
semi-strong and strong form. The weak-form of the market states that the old
information about a stock market price is irrelevant since the current price in
the stock markets represents everything including the old information.
Therefore an investor cannot predict on the current or upcoming stock market
price using the old stock information data as it is random. The semi-strong form of the
market states that the current stock market reflects all public information.
This includes even the old stock market information. This form assumes that the
market adapts quickly to new information. Therefore an investor cannot benefit
from new information because the market has already absorbed the information. On the part of strong
efficiency market, it states that all the information, both public and private,
is priced in the stock market. Therefore no investor can gain the advantage
over the market as a whole (Thune, 2017).

‘Shareholders
will never know our capital budgeting decisions’

Actually, considering market efficiency, the
statement of shareholders will never know our capital budgeting
decisions is not true. In an efficient capital market, Fama believes
that there are a lot of rational investors in the market, they actively
participate in analyzing, pricing and dealing with the stock in order to chase
the large profit, the stock price could make quick and accurate reaction
towards new information (RP O’Neill, 2005). So, the stock price
can reflect all the information, which not only includes information published
by corporation, industry, country or even the world but also includes private
information about people or groups and internal non-public information. In such
a market, when investors making decisions about buying or selling, they have
known all the information related to the price, which tends to be an optimal circle (Fama, 1970). Under the
circumstances, shareholders could acquire information about corporate decisions
and other items and even analyze if there is something wrong with the
information published by corporations (Malkiel, 2003).

According to the different degree of
information reflected on stock price, Harry Roberts divided efficient market
into three types. General speaking, in a weak-form efficient market, the stock
price only reflects historical information related to the stock itself, such as
stock price, trading volume and so on. Therefore, investors can’t get any help
from the changing trend of stock price, they could not make prediction about
the corporation based on the information. In this sense, shareholders may not
be able to get access to the corporation’s capital budget decisions (Clifford
Asness, 2014).
In the second type of efficient market, that is semistrong-form efficient
market where stock prices could reflect all public information, which includes
not only the historical information of stock price and trading volume, but also
all the latest information published by corporation, such as corporate
earnings, dividends and interest rate policy and so on. As long as the
information disclosure, the stock price will get adjusted quickly and
accurately, so that all public information related to stocks are fully
reflected on the stock price. Therefore, through the analysis of corporate
annual report and other public information, shareholders can obtain the
relevant information. In strong-form efficient market, the price of the stock
reflects all the information, public or non-public. In this sense, it includes
not only historical information and public information, but also internal
information and private information. Therefore, shareholders can easily know
the capital budget decisions of the corporation (Shiller.,
2002).

In a word, in the efficient capital market,
managers should fully believe the price of stock and believe that the price of
each stock contains all available information. Stocks in the market can be
reasonably priced and show the fair value, managers need to be cautious and
devoted into create value from hard working instead of taking shareholders as
the ignorant and fool them.

‘We
cannot fool shareholders and the market. The market will punish the company if
we have made bad capital
budgeting decisions’

Shareholders are not easily
fooled by glossy financial reports or ‘creative accounting’ techniques
(Isaac, 2003).
The efficient market theory regards as market prices already contain all the
available information, so if the market is efficient, the analysis and
reporting of past information and security prices are futile. That is to say,
market efficiency will let shareholders know when they should invest or divest?and good invests will be reflected timely in
the change of stock prices; both risks and returns can be approximately showed
up in prices.

Next step is to analyze the implications of
market efficiency for corporate managers on the three forms of
market efficiency.

In Weak-Form EMH, all the historical market data
should have no relationship with future rates of returns. If corporate managers
decide to get excess return stocks based on their past performance and
historical data, then they would be
punished by market. For example, Jack who is a young man works at Stock
Exchange, and he has been interested in investements. Then Jack noticed that the
security price of Barclays PLC has been going up between 16/10/17 and 24/10/17.
On 25 Oct 2017, Jack decided to purchase 10 shares of BARC. L’s stock for ?197.00 per share. Soon Jack has seen the price droped to ?182.40 per share. When market is weak-form efficient, it will not
allow anyone to make profits
that far exceed
the returns of the market
(based on past price pattern).

In Semi-Strong-Form EMH, Technical analysis and
fundamental analysis based on public information are also invalid. However,
this type of theory has always been controversial. Here, it should be better
understood as when the market is in a semis-strong-form state, neither
technical analysis nor fundamental analysis can help predict future price
movements. However, non-public information can be used to earn above-average
returns. When the company wants to make capital budgeting decisions by (relying
on) some public information, they cannot earn abnormal returns in imagine.
Therefore, company management cannot obtain more shareholders’ support or
market preference on the basis of public information. More often than not, we
can say that the market has fooled the management of the company, and that the
public information mislead them when managers make decisions. In this form of EMH, which suggests only insider
information can benefit shareholders seeking to earn abnormal returns on
investments.
In Strong-Form EMH, the information reflected by prices include all public
information and all insider information. Here is an example from Jan, 2015.
Shintaro Ishihara is a chief engineer works at Osaka Automobiles. He was
working on a new advanced model of the car, which has been a great successful
project. He was convinced that the project would lead to a price increase, so
he bought 10, 000 shares in Osaka Automobiles at $25 a share.He was surprised
to find that even after the success of the project, the stock price did not
rise. The market seems to be strong-form efficient because it had adjusted the
share prices of Osaka Automobiles to meet the expected net present value of new
projects. It already reflected the inside information.

 

Conclusion

Overall the main implication drawn from market
efficiency relates to impossibility of an investor to outperform or beat the
market on share prices (get a return above average or make abnormality returns
from their investment) as the prices clearly reflect the information and other
securities on the market. Before the prices are set for shares, the relevant
information is taken into consideration such as the economy status, company
value etc. at the given time. Market efficiency is important for an investor,
as it allows them to make a sensible or accurate choice when investing rather
than making an assumption which could cause massive losses. The prices are
changed extremely fast, giving the investor no time to find a loophole in order
to have an edge over the market. In efficient markets, it is hard for an
investor to actually predict, this is because the prices are completely priced
randomly which means that an investor cannot plan beforehand. One of the common
ways to measure the market efficiency is to see when the information is made
available and then see how long it takes the security’s price to actually
interpret or show this data. Depending on the country’s economy level,
political and social activities can have a great impact on the way the stock
exchange works. when the availability of information is high, the market
efficiency will also be high meaning that it will eliminate any loopholes
therefore even the insiders will not have the ability to make unbelievable
profits, this is because the same information is given to everybody else.   

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