Market efficiency - Assignment Example

? Market Efficiency Private market efficiency refers to the measure of access to information that market players can use to maximize their gains on investment at a minimum transaction cost (Jarrow & Larsson , 2011). Market efficiency widely known as the Efficient market Hypothesis (EMH) and introduced by Eugene Fama in 1970 stresses that market prices is a reflection of all the available information to the investors regarding a particular stock at a particular time of trading. According to Fama‘s interpretation of an efficient market is a situation were no individual investor has an advantage over others in predicting excess returns on securities above the existing market price (Jayasuriya, 2008). This claim is based on the premise that at any given time no one will have information over and above what is available to other players. The information necessary to make judgment is often readily available to all players at the time of trading and for this reason no individual player can beat the market. Valuation of investment is the main determinant of whether a market is efficient or not and where the inefficiencies are evident. An efficient market can be determined through market prices considering that it is only estimate for measuring deviation from true value (“Market Efficiency”, 2011). This is because an inefficient market will only be determined by market price deviation from the true value. Efficient market must be supported by a number of conditions most of which revolved around valuation and information availability for it to take place. The is means that information and market prices are integral components of market efficiencies consider that investors make investment strategies based on the information they have assuming that at a given time traded assets(s) are under or overvalued (Yang & Leatham, 1998). The market prices in an efficient market are often unbiased estimate of the asset’s true value and they are expected to shift randomly depending on the behavior of the investors. Investors play a significant role in bringing efficiency in private markets considering their diverse reaction to available information. A number of conditions need to take place in the private market place in order for efficiency to be achieved. In other words, market efficiency does not happen automatically as certain forces drive it. The first condition is the existence of profit maximization investors (“Market Efficiency”, 2011). Investors will always try to take advantage of every opportunity that comes their way to make profits. This is often based on the perception of the investors that the market is inefficient and one can leverage on the inefficiencies to beat the market. In other words, the investors must recognize the potential for bigger returns, replicate their beat the market strategies and invest their resources repeatedly until the end of inefficiency (Lee, etal, 2009). The more the investors continue to actively participate in trading activities the more likely they create market efficiency. For instance continuous sale and purchase of stocks will always have a double edged impact considering that market prices can be pushed above or below fair value at every point in time. This makes it very difficult a single or a group of investors to predict the existing undervalued stocks irrespective of the applied investment strategy. The timing and nature of the information available to the investors is also another important condition for achieving market efficiency. Information availability is an integral part of market efficiency considering that an efficient market is defined based on the kind of information that is reflected on the price and available to the investors. Take for instance a strong form efficiency which is exudes that under such a circumstance an investor with insider information will not be able to make excess gains over other because the market prices reflects all the information both private and public. It is noteworthy that market efficiency can only be achieved when a certain group of investors does not have undue advantage over other investors with respect to access to vital investment information. This may be experienced in cases of insider trading where material information about a company is leaked to the investors. Insider trading is an illegal act because it create unfavorable investment platform. This information is critical to investors who are trying to take advantage of market inefficiencies as they use it to come up with investment strategies that would enable them make excess returns over and above existing market returns (Mendes, 2006). The prices according to inefficient market condition are only responsive to the available information in the surrounding. Much importantly, the nature of information that is available to the investors does not need to be limited to financial research and news lone but also information from trending political, social and economic events. Whether rumored or have some element of truth this information should be available to all the investors at the same time. According to Efficient Market Hypothesis (EMH), no individual or group of investor will out profit other players based on the fact that they are privy to the same information. The efficient market is categorized into three versions based on the timing and nature information that is available to all the investors at a given time. They include weak form efficiency, semi-strong form efficiency and strong form efficiency (“Market Efficiency”, 2011). These versions of efficient market show the extent to which information plays a significant role in shaping efficiency in private market place. Under a weak for efficiency the current prices is often a reflection of the information about past prices and in such situations investors are only left with the option of strategizing to take advantage of market inefficiencies based on past prices. This will lead to market efficiency because it will be extremely hard for investors to successfully identify undervalued stocks using past data only. Under semi-strong form efficiency the current prices is often reflects a combination of information about both past as well as current market prices (Ardalan, 2006). Strong form efficiency highlights that market prices adjust very quickly and in a uniform manner to publicly available new and events and in that case, investors will often overreact to this information thus limiting their chances of making excess gains. Finally, under strong-form efficiency, the market is often flooded with up to date private and public information and as such, prices are often a reflection of this current information. This makes it hard for investors to make excess returns considering the speed at which adequate information is available to everyone in nondiscriminatory way. By looking at different forms of market efficiency namely the weak, semi-strong and strong someone can be deluded that no investor or group of investor can make excess gains over and above market gains. People may also assume that prices cannot move below or above fair value. However, market efficiency operates contrary to all these assumptions. First considering the number of all investors actively participating in the market, the law of probability sums up that a significant number of investors will successfully manage to make excess gains over a long period simply based on luck but not that their investment strategies did work (Muhammad & Rahman, 2010). The same case applies with individual investors who can beat the market at any given time prior to transactions costs. The fact that efficient works in the sense that no investors can beat the market consistently through a common investment scheme does not imply that market prices cannot deviate from true value. In fact, market efficiency takes into consideration random shift in market prices over and below true value as it does not expect the market prices to be at equilibrium. Another condition of efficient markets involves the fact that prices become not predictable but random. This condition according to EMH school of thought is called “random walk” and it is considered the major cause of investment strategy failure and thus inability to beat market consistently. From the definition of market efficiency, someone can easily conclude that it is a market where an unbiased estimate of an investment’s fair value is the market prices (Mendes, 2006). This means that market efficiency does not support a market price to be equivalent to the fair value of an investment at all times. However, the inconsistency between market price and true value need to be unbiased in the sense that the prices can increase above or reduce below the investment’s true value. The inconsistent nature of market price around true value also should be random in the sense that the asset traded has an equal chance of being over or undervalued at any given time. The random nature of market price as it deviate from true value supports EMH because it makes it hard for any group of investors to correctly predict under or overvalued assets based on the investment strategy applied. Another condition for creating market efficiency involves existence of assets to trade on. In other words, market efficiency cannot be achieved without assets considering that they are major cause of inefficiency. Malkiel (2003) asserts that most investors are often optimistic of beating the market in order to earn excess return. Inefficiency in the market plays an important role to the investors because it provides an opportunity for a scheme that if properly utilized can assist them beat the market. However, the cost of carrying out the investment strategy must be lower than the expected gains from the scheme. Another major condition for efficient market to take place involve the fact the market must be large and liquid. The market must be in a position to accommodate many investors to allow the market become efficient. Additionally the market must be liquid just like in the case of financial market in particular securities market where people trade in stocks and other securities. Securities market consist of large pool of investors who are willing and ready to sell and or buy particular stocks at a particular time at a specific price making it one of the highly liquid market. These five conditions required in the private market place in order for efficiency to be achieved cannot exist in education. Education though used in certain instance as business is much more of social service and for this reason it does not qualify to be an effect asset for trading. Education cannot be valued unlike securities considering the diversity and the gaps that exist in education. The biggest asset in education is certainly learning infrastructure and this vary in different institutions and for this reason, trading in education becomes unlikely. Market price play a significant role an efficient market considering that it is used as a benchmark for measuring deviation from true value (Jarrett, 2010). Investment in education, does not involve issues such as market price and true value and this makes it difficult to incorporate it into efficient market. Lack of measure for the market value and true value of education means that the issue of unbiased price is not taken into consideration. Furthermore, random deviation of market price from the true value does not feature in education. It is noteworthy that education does not fit into various forms of efficiency. This means that education cannot be discussed under weak form efficiency, semi-strong form efficiency and strong form efficiency. These are the three most important elements of efficient market considering that its definition is linked to these three forms (Howden, 2009). For instance, it is very hard to understand how education will work under semi strong form efficiency, which identifies current market prices based on a combination of past prices and public information. The same case applies with weak form efficiency as well as strong form efficiency. Information is another critical condition in efficient market that does not seem to be highly important in education as in other sector such as financial markets. Most of the information both private and public information is uniform across the entire sector it is not ideal for profiteering. Public and private information about education is not that sensitive to attract investments considering that most of learning institutions are not for profit. In fact, most of the learning institutions are run by the public sector and for this reason, they may not consider any information as sensitive and controlled as in cases of insider trading law. The fact that education is not attractive to investors to make them come with strategies to exceed gains than those set by the market is a clear justification that conditions of efficient market cannot exist in education. In other words, one of the major conditions for efficient market to exist requires that profit-maximizing investors must be present. For this to happen the investors must be in a position to recognize the potential for excess gains (“Market Efficiency”, 2011). This is unlikely in education considering that it is tough to establish the potential for excess returns in education. Inefficiencies that investors look for in efficient market do not seem to be realistic in education. These inefficiencies are vital because they are the source of schemes that investors use to make excess gains but they do not seem to be a concern in education. There is also a requirement that assets must be available for trading considering that they are the major source of inefficiency in the market. Unlike in financial sectors, there are no clear assets in education that can cause inefficiencies and at the same time traded on by the investors. The fact that transaction costs have to be higher than the expected profit from the scheme in order to create an efficient market is a major undoing to education. This because in certain education facilities especially not for profit one the cost of transaction is often equivalent to gains earned from the services provided. The most efficacious market for the education is public. A public education plays a significant role in correcting market inefficiencies that may exist in the system. It is obvious that a public education system is highly equitable considering that it caters for interests of students nondiscriminatory. Interests of all the students irrespective of social class are taken into consideration. Private school unlike public school charge parents exorbitant amount of money to offset the costs they incur in running the institution (Rothstein, Carnoy & Benveniste, 2003). This means that children from socially disadvantaged households cannot have access to private schools leaving such kind of schools to children from well to do families. In other words, private learning institutions are discriminatory based on social class considering that children from less fortunate families cannot access their facilities. According to Kennedy (2011) public schools on the other hand cater for all the funding needs of public schools from as low as primary to higher learning institutions and in some cases as from kindergarten. Public education ensures that there is coherence in learning considering that they fund every learning process ranging from leaning infrastructure, employee teachers, developing curriculum, certification and standardized learning materials. The united state s likely to face stiff competition especially from the emerging economies such as India, Brazil, china, and Singapore in various economic sectors but the biggest shock will be in the knowledge-based economy. These emerging economies are growing too fast and this requires them to develop adequate human resources that will allow them compete effectively not only in the local but international market. Not only production but labor also forms an integral component of economic growth considering that human resources services supplied is used in computing GDP and this makes countries strive to increase their pool of highly efficient human resource and this creates competition in the worlds global economy. References Ardalan, K. (2006). The community reinvestment act and efficient markets debate: A review of theory. Journal of Commercial Banking and Finance, 5(1), 25-42. Howden, D. (2009). Fama's efficient market hypothesis and mises's evenly rotating economy: Comparative constructs. Quarterly Journal of Austrian Economics, 12(2), 3-12. Jarrett, J. (2010). Efficient markets hypothesis and daily variation in small pacific-basin stock markets. Management Research Review, 33(12), 1128-1139. Jarrow , R & Larsson , M. (2011). The Meaning of Market Efficiency. Retrieved April 20, 2013 from: http://www.cba.uh.edu/departments/finance/documents/RJarrow%20MarketEfficiency6.pdf Jayasuriya, S. (2008). Efficient market frontiers for the emerging economies of china and india. The Asia Pacific Journal of Economics & Business, 12(2), 45-63,93. Kennedy, R. (2011). Private vs Public Schools: Private and Public Schools Compared. Retrieved April 20, 2013 from: http://privateschool.about.com/cs/employment/a/teachingcond.htm Lee, A et al. (2009). Financial analysis, planning & forecasting: Theory and application. Singapore: World Scientific. Malkiel, B. (2003). The efficient market hypothesis and its critics. The Journal of Economic Perspectives, 17(1), 59-82. Market Efficiency - Definition And Tests. Retrieved April 20, 2013 from:http://people.stern.nyu.edu/adamodar/New_Home_Page/invemgmt/effdefn.htm Mendes, G. (2006).Free Market Efficiency Conditions, Desirability, Optimality. Retrieved April 20, 2013 from: http://strategytank.awardspace.com/articles/Free%20Market%20Efficiency%20-%20Conditions,%20Desirability,%20Optimality.pdf Muhammad, N., & Rahman, N. (2010). Efficient market hypothesis and market anomaly: Evidence from day-of-the week effect of malaysian exchange. International Journal of Economics and Finance, 2(2), 35-42. Rothstein, R., Carnoy, M & Benveniste, L. (2003). All Else Equal: Are Public and Private Schools Differents? London; Routledge publishing. Yang, J., & Leatham, D. (1998). Market efficiency of US grain markets: Application of cointegration tests. Agribusiness (1986-1998), 14(2), 107-107. Read More