A brief understanding of market efficiency. this ppt includes a definition of market efficiency, what are the factors to be considered, degree of ME-
first-degree,
second degree
third degree,
why the study of market efficiency is important.
An example to understand.
3. Definition of market efficiency
• According to market efficiency, prices reflect all available information about a
particular stock or market at any given time.
• As prices respond only to information available in the market, no one can out-
profit anyone else.
• One view of EMH suggests that not even insider information can give one
investor an edge over others.
4. Assumptions
• For a market to become efficient, investors must perceive the market is
inefficient and possible to beat.
• A market has to be large and liquid.
• All the investors are rationale and have full access on the information.
• Transaction costs have to be cheaper than an investment strategy's expected
profits.
• Investors must also have enough funds to take advantage of inefficiency
5. Degrees or forms of efficiency
• Strong efficiency - This is the strongest version, which states all information in a
market, whether public or private, is accounted for in a stock price. Not
even insider information could give an investor an advantage.
• Semi-strong efficiency - This form of EMH implies all public information is
calculated into a stock's current share price. Neither fundamental nor technical
analysis can be used to achieve superior gains.
• Weak efficiency - This type of EMH claims that all past prices of a stock are
reflected in today's stock price. Therefore, technical analysis cannot be used to
predict and beat the market.
6. Factors Affecting Market’s Efficiency
• The number of market participants : The more investors and analysts that
follow a financial market , the more efficient it becomes .
• Information availability and financial disclosure : All investors should have
access to the necessary information to value securities. This should promote
market efficiency .
• Limits to trading : Some researches argue that restrictions on short selling
impede market efficiency.
7. Why is market efficiency important ?
The idea of market efficiency is very important for investors because it allows
them to make more sensible choices. The only real way that they can get above
average profits through investments in the different markets is by taking
advantages of any abnormalities when they occur. When the market is running
efficiency it will not be possible for investors to make above average profits, but
any abnormalities tend to be removed , but while they are there it is a good news
for investors is that there are many economists who argue that there will never be
full market efficiency so there will always be a way to get an edge.
8. Advantages of market efficiency
• Save money of innocent investors: The first and foremost advantage of the
efficient market is it helps in saving money of innocent people who try to enter
into the stock market thinking that they can earn huge money by following the
advice of technical analyst or fundamental analyst.
• Neutralizes Self Made Experts: Another benefit of this theory is that once you
know that the stock market is efficient and reflects the true value of stocks that you
will not get into the trap of buying blindly any stock on the basis of the
recommendation of self-made.
• Saves time :Once you are aware that stock markets are efficient than you do not
need to spend too much in analyzing the balance sheet, profit and loss accounts,
and technical charts of stocks as according to this theory they are of no use and one
cannot make an abnormal return by taking the decision on the basis of these tools.
9. Disadvantages of market efficiency
• Markets are irrational : The first and foremost disadvantage of the efficient
market is that while this theory argues that markets are efficient but history is filled
with examples where stock markets become irrational due to panic and stocks were
available at throwaway prices and people made a lot of money by buying stocks at
throwaway prices.
• Fundamental and Technical Analysis Works: The argument that fundamental
analysis and technical analysis are a waste of time is also not correct because just
chances of accidents happening due to the bad driver are more as compared to a
good driver in the same way.
• Stock Markets is not Gambling: In simple words risks taken in stock markets are
calculated ones as opposed to gambling which is nothing but pure speculation.
10. Efficient Market Hypothesis (EMH)
• The efficient market hypothesis (EMH), alternatively known as the efficient
market theory, is a hypothesis that states that share prices reflect all information
and consistent alpha generation is impossible.
• According to the EMH, stocks always trade at their fair value on exchanges,
making it impossible for investors to purchase undervalued stocks or sell stocks
for inflated prices. Therefore, it should be impossible to outperform the overall
market through expert stock selection or market timing, and the only way an
investor can obtain higher returns is by purchasing riskier investments.
11. Conclusion
• In the real world, markets cannot be absolutely efficient or wholly
inefficient. It might be reasonable to see markets as essentially a mixture
of both, wherein daily decisions and events cannot always be reflected
immediately in a market. If all participants were to believe the market is
efficient, no one would seek extraordinary profits, which is the force that
keeps the wheels of the market turning.