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Sir please correct me about the following relating to Capital Market Efficiency Hypothesis:
1) A market is said to be “efficient” if share prices adjust quickly in the stock market based upon the performance of the company
[In other words, if there is a company’s announcement then market is said to be efficient if the share prices of the company is quickly adjusted in correspondence to the information available at that time to the stock market]?
2) Weak form is where all past information and data are fully reflected in the price of securities.
(This means that investors cannot earn abnormal gain based upon information)3) Semi-Strong form is where the current share prices reflect both: relevant information about past price movements & All knowledge which is available publicly.
(This means that individuals cannot ‘beat the market’ by reading the newspapers or annual reports, since the information contained in these will be reflected in the share prices)
3) Strong form is where hypothesis asserts that all information is fully reflected in the price of securities, including insider information.
(No investor can earn excess returns using any information whether publicly available or not)
4) Lastly, please correct me since we cannot earn excess returns on the weak & strong form; Can we earn abonormal gains on semi-strong form??
Thank you for your time! 🙂
Everything you have typed is correct.
However I do not know where you are getting the term ‘abnormal gains’ from. If the market is weak or semi-strong, then investors with more information that other investors can make gains by using that information. They can deal in shares knowing that only when other investors get the information the share price will change and so they can gain as a result.
If the market is strong-form efficient then this cannot happen because no one investor will have information that other investors do not have.
What you are saying is that under weak or semi-strong forms, the investors can earn gains (not abnormal gains which I get the term from BPP kit as u asked) because they have more information than other investors about the company’s progress for the future such as its share prices will increase in future because company has invested money in the positive NPV project – hope I am correct here!
Please also comment on these doubts of mine because I am confused here a little!
1) Can anyone beat the market based on the information available to them – Is that correct by beating the market means that they can earn huge profits out of the available information?
2) In weak-form market nobody can make gains based on past price movements BUT what
information do they need to make a gain – public information?3) Same with the semi-strong market nobody can make gains based on public information available BUT what information do they need to make a gain here – private information?
4) Under Strong form market Share prices react before company announcement such as [If a company announces that it decided yesterday to invest in a new project with a huge positive NPV. But the Share prices doubled yesterday] – here the market is more efficient with the information available to investors on the very same day the share prices are adjusted!
Hope I didn’t bother you too much on this 🙂 But Thanks for your help 🙂
I think that the following should answer all four of your. questions (and certainly is as much as could ever be needed for the exam).
Share prices are always based on the future expectations of the overall shareholders of the company – how well shareholders overall are expecting the company to perform in the future based on the information that is available to all shareholders.
One individual may think that the company will do better than everyone else expects so they will buy shares now, and if what they think turns out to be true then later the share price will increase and that individual will have made a gain. However what they think might not turn out to be true and the company might do worse, in which case the share price will fall and the individual will have made a loss. However that is only happening because the individual is thinking differently than the majority of the shareholders.
However, the problem is when an individual thinks differently because they have information that the majority of shareholders do not have. Then they will know for sure that the company will do better than the majority are expecting, and that when the majority do find out then the share price will increase. They can then buy shares now, and be sure that the price will increase in the future and that they will therefore make a gain.
That is why the rules try to make it so that all shareholders have access to all relevant information – if that was the case then what I have written in the last paragraph cannot happen. Obviously there is some information that the company will not want to make public immediately because it could cause problems (such as letting competitor companies find out about their plans), which is why there are rules stopping insider dealing (i.e. directors etc. using information they have that is not available to the majority of shareholders).
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