Why capital markets should be efficient
Requirements of an efficient market
Large number of market participants, acting independently
New information generated randomly
Prot-maximizing investors adjust prices rapidly due to new info.
This results in
Security prices independent and random
Security prices reflect new info
Expected returns = risk of stock (stocks lie on sml (CAPM))
Efficient market hypothesis(Others)
Random walk hypothesis
Changes in security prices are random
Fair game model
Market price reflect all info, expected return =risk
Efficient market hypothesis (three sub groups)
Weak-form emh
Reflects all security past info, trade volume, rates of returns block trades ect.
Past rates of return have no relationship with future rates of return.
Reflects all historical info only
Li1le to gain from using trade rules that based on past data
Inefficient market, certain people know info that others don’t thus sales reports
not announced(insiders can use) ,if a1ained , provide a unfair advantage to
others(outsiders)
Fundamental analysis used But not technical analysis.
Semistrong-form emh
Includes weak-form
Prices reflect all public info , ratio’s , political news, thus they are already adjusted.
Due to being adjusted no one should gain above average returns from trading
a6er info is public
Ceo’s and insiders have a slight advantage over outsiders.
Technical ,fundamental analysis are not effective.
Strong-form emh
Prices reflect all public/private info
No investor is able gain above average rates of return.
All info is cost free and available to everyone at the same time.
Ceo’s ,insiders, outsiders all know info at the same time.
Tests with weak-form emh
