2A Description of Efficient Capital Markets An efficient capital market is one in which stock prices fully reflect available information.The EMH has implications for investors and firms.Since information is reflected in security prices quickly, knowing information when it is released does an investor no good.Firms should expect to receive the fair value for securities that they sell. Firms cannot profit from fooling investors in an efficient market.Market efficiency is a funny thing:Markets are efficient precisely because there are lots of well- paid, well-financed, and smart security analysts who don’t believe that the markets are efficient…and their actions make the market efficient!
3Reaction of Stock Price to New Information in Efficient and Inefficient Markets Overreaction to “good news” with reversionDelayed response to “good news”Efficient market response to “good news”Days before (-) and after (+) announcement
4Reaction of Stock Price to New Information in Efficient and Inefficient Markets Efficient market response to “bad news”Stock PriceDelayed response to “bad news”Overreaction to “bad news” with reversionDays before (-) and after (+) announcement
5The Different Types of Efficiency Weak FormSecurity prices reflect all information found in past prices and volume.Semi-Strong FormSecurity prices reflect all publicly available information.Strong FormSecurity prices reflect all information—public and private.
6Weak Form Market Efficiency Security prices reflect all information found in past prices and volume.If the weak form of market efficiency holds, then technical analysis is of no value.Often weak-form efficiency is represented asPt = Pt-1 + Expected return + random error tSince stock prices only respond to new information, which by definition arrives randomly, stock prices are said to follow a random walk.Stock prices following a random walk is not the same thing as stock prices having random returns.
7Semi-Strong Form Market Efficiency Security Prices reflect all publicly available information.Publicly available information includes:Historical price and volume informationPublished accounting statements.Information found in annual reports.
8Strong Form Market Efficiency Security Prices reflect all information— public and private.Strong form efficiency incorporates weak and semi-strong form efficiency.Strong form efficiency says that anything pertinent to the stock and known to at least one investor is already incorporated into the security’s price.
9Relationship among Three Different Information Sets All information relevant to a stockInformation set of publicly available informationInformation set of past prices