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Market Efficiency Essay

523 words - 3 pages

Market efficiency
Market efficiency suggests that at any given time, prices fully reflect all available information on a particular stock and/or market. According to the Efficient Market Hypothesis (EMH), no investor has an advantage in predicting a return on a stock price because no one has access to information not already available to everyone else.
A market has to be large and liquid. Information has to be widely available in terms of accessibility and cost and released to investors at more or less the same time. Transaction costs have to be cheaper than the expected profits of an investment strategy. Investors must also have enough funds to take advantage of inefficiency until, according to the EMH, it disappears again. Most importantly, an investor has to believe that she or he can ...view middle of the document...

Semi-strong efficiency - the market is efficient in the semi-strong sense if shares prices respond instantaneously and correctly to newly published information. The implication is that there is no advantage in analyzing publicly available information because as soon as information becomes public, it is immediately incorporated into prices. Example: Wall Street Journal argues that stocks are currently overvalued or share repurchasesWeak Efficiency - share prices fully reflect the information contained in past price movements. Price movements are totally independent of previous movements, so it is impossible to earn superior profits based on the knowledge of past price returns. Assuming risk neutrality, the weak form of the EMH reduces to the random walk hypothesis. Example: Investing in ‘loser’ stocks that have done very badly in some prior time period that yield excess returnsPassive Index funds vs. Actively Managed Funds Actively managed funds have high fees and they take more risks (which may result in higher returns when manager's bets are right). Passive index funds don't bother taking bets.Here is one study that shows active managed funds can kick the crap out indexes: (ABSTRACT: We examine predictability for stock mutual funds using risk-adjusted returns. We find that past performance is predictive of future risk-adjusted performance. Applying modern portfolio theory techniques to past data improves selection and allows us to construct a portfolio of funds that significantly outperforms a rule based on past rank alone. In addition, we can form a combination of actively managed portfolios with the same risk as a portfolio of index funds but with higher mean return. The portfolios selected have small but statistically significant positive risk-adjusted returns during a period where mutual funds in general had negative risk-adjusted returns.) |

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