The document discusses market efficiency and the efficient market hypothesis. It defines market efficiency as prices reflecting all relevant financial information, so there are equal opportunities for buyers and sellers. The efficient market hypothesis states that stock prices instantly change to reflect new public information, making it impossible for investors to consistently earn above-average returns. The hypothesis is criticized for not explaining market bubbles that have occurred. The document also explains the weak, semi-strong, and strong forms of market efficiency and provides examples to illustrate market efficiency.

1. ABV-Indian Institute of Information Technology and
Management, Gwalior
Ravindra Nath Shukla
Research Scholar
Market Efficiency
and
Efficient Market Hypothesis

2. Source credit : Investopedia

3. What Is Market Efficiency?
 Market efficiency refers to a market where
prices represent all relevant financial
information about an underlying asset or
security.
 The more information that all market players
will have, the more efficient the market is.
 It, thus, provides an equal opportunity for buyers
and sellers to execute trades and make profits
while minimizing transaction costs.

4. Source credit : WallstreetMajo

5. Key Takeaways
 The market efficiency occurs when current market prices reflect
all relevant financial information about an underlying asset or
security.
 The more information available to all market participants, the
more efficient the market becomes. Access to the same data
makes investors unable to predict prices and outperform the
market.
 An efficient market gives equal opportunity for buyers and
sellers to profit in a liquid and highly competitive market while
minimizing transaction costs, the likelihood of arbitrage, and
above-market gains.
 The concept is linked to American economist Eugene Fama’s
efficient market hypothesis in 1970 and is useful in commercial
and financial scenarios.

6. Forms of Market Efficiency
 #1 – Weak Market Efficiency
 #2 – Semi-Strong Market Efficiency
 #3 – Strong Market Efficiency
Source credit : WallstreetMajo

7. Source credit : WallstreetMajo

8. #2 – Semi-Strong form
 The semi-strong form of market efficiency assumes that stocks adjust
quickly to absorb new public information so that an investor cannot
benefit over and above the market by trading on that new
information.
 It indicates that current prices consider all publicly available
information about an asset or security.
 It also offers previous price details. As a result, it discourages
investors from benefitting above the market by trading on the inside
information.
 This implies that neither technical analysis nor fundamental analysis
would be reliable strategies to achieve superior returns.
 Any information gained through fundamental analysis will already be
available and thus already incorporated into current prices.
 Only private information unavailable to the market at large will be
useful to gain an advantage in trading, and only to those who possess
the information before the rest of the market does.

9. #1 – Weak form
 This form reveals all past information about asset or security pricing.
 The weak form of market efficiency is that past price movements are
not useful for predicting future prices.
 The past pricing details reflected in current prices are insufficient to
assist investors in determining correct future trading prices.
 If all available, relevant information is incorporated into current
prices, then any information relevant information that can be gleaned
from past prices is already incorporated into current prices.
 As a result, the weak form market efficiency will only result in asset
undervaluation or overvaluation, affecting trade decisions.
 Future price changes can only be the result of new information
becoming available

10. #3 – Strong form
 The strong form of market efficiency says that market prices reflect
all information both public and private.
 It is the result of combining weak and semi-strong forms.
 This form shows market prices based on all accessible information
(public, insider, and private).
 This insider knowledge, however, is neutral and available to all
traders.
 As a result, despite having access to insider information , it ensures
that all investors profit equally.

11.  The Efficient Market Hypothesis (EMH) states that the
stock asset prices indicate all relevant information
very quickly and rationally.
 Such information is shared universally, making it
impossible for investors to earn above-average returns
consistently.
 The assumptions of this theory are criticized highly by
behavioral economists or others who believe in the
inherent inefficiencies of the market.
Efficient Market Hypothesis

12. Source credit : WallstreetMajo

13. Let us look at some assumptions of the efficient market hypothesis
theory.
 Investors in the market may act rationally or normally.
 If there is unusual information, the investor will react unusually.
 Which is normal behavior, or doing what everyone else is doing is
also considered normal behavior.
 The stock price indicates all the relevant information shared
universally among the investors.
 It also states that the investors cannot exploit the market since they
need to act as per the market information and make decisions
accordingly.
Assumptions Of EMH

14.  Economist Eugene Fama gave the efficient market hypothesis in the
1970s.
 According to this hypothesis, the efficient market will not provide
any profitable opportunity for trading.
 Thus, attaining a superior return consistently in such a condition is
impossible.
 Time is an essential factor within which the market spreads
information.
 This time gap provides traders the opportunity to exploit the
inefficiency.
Efficient Market Hypothesis

15. Examples of Market Efficiency
Example #1
 Assume that companies A and B are up for
takeover
 These companies’ stock values are lenient
and stable for a few days, with only minor
fluctuations.
 However, as soon as it was announced that a
well-known corporation would be taking
over both of them, their stock prices
jumped.
ABC
Ltd.
B
A

16.  In this instance, the takeover
announcement adds new information to
the current data for the companies’
stocks.
 Resulting in a price change.
 As a result, the rise in stock prices
indicates new positive information to
the companies.

17. Example 2
 Mary, a trader, is looking forward to purchasing stocks at a
reduced price on one market and selling them at a higher
price on another market.
 This type of trading, known as arbitrage.
 Arbitrage is the process of profiting from a pricing
discrepancy.
 Unfortunately, even though an arbitrager can make a risk-
free return in this situation, the market’s overall efficiency
suffers.
 As a result, markets prohibit arbitrage and impose
restrictions on acts that impede market efficiency.

18. Example 3
 Suppose a person named
Johnson holds 900 shares of
an automobile company, and
the current price of these
shares trades at $156.50.
 Johnson had some relations
with an insider of the same
company who informed
Johnson that the company had
failed in their new project and
the price of a share would
decline in the next few days.

19.  Johnson had no faith in the insider and held
all his shares. Then, after a few days, the
company announces the project’s failure,
dropping the share price to $106.00.
 The market modifies the newly available
information.
 To realize the gross gain, Johnson sold his
shares at $106.00 and a gross gain of
$95,500.
 If Johnson had sold his 900 shares at $156.50
earlier by taking the insider’s advice, he
would have earned $140,850.
 So, his loss for the sale of 900 shares is
$140,850-$95,500 i.e., $45,350.

20. Importance
 This theory takes into account the fact that there are
always some special cases or outliers.
 Who are able to use the time gap between the old pices
and change in price due to new information to earn extra
return.
 The importance of efficient market hypothesis also lies
in the fact that it is useful in the asset pricing models.
 There is no need of government intervention since stock
prices adjust automatically.

21. Criticism
 One of the biggest reasons behind the
criticism of the efficient market hypothesis
is market bubbles
 If such assumptions were correct, there was
no possibility of bubbles and crashing
incidents.
 Such as stock market crash and housing
bubbles in 2008 or,
 the tech bubble of the 1990s.
 Such companies were trading at high values
before hitting.
 Thus, this criticism is an important
argument for efficient market hypothesis
testing.
Existence of Market Bubbles:

22. Wins against the Market:
 Some investors, such as Warren
Buffett, won against the market
consistently.
 He had consistently earned above-
average profit from the market for
over 50 years through his value
investing strategy.
 On the other hand, some behavioral
economists also highly criticize the
efficient market hypothesis theory
because
 they believe that past performances
help predict future prices.

23. Efficient Market Hypothesis Vs Behavioral
Finance
 Efficient market hypothesis states that markets
are efficient since information quickly spreads
 whereas behavioral finance states that investors
tend to be irrational in their judgement.
 Following are the key differences of Efficient
Market Hypothesis Vs Behavioral Finance.

24. Efficient Market Hypothesis Behavioral Finance
It states that market is in equilibrium
since information spreads quickly.
It states that due to behavioral
differences, market may not be in
equilibrium.
Investors are always unbiased.
It states that investors may be use
their bias while investing.
It makes market unpredictable.
Irrationality tend to make investors try
and predict the market.
No planned approach/ is possible.
Investors try to make a planned
approach.

25.  Ravindra Nath Shukla
 ravisky1989@gmail.com
ravindra@iiitm.ac.in
 Slide share : ravisky1989