Corporate Finance Corporate Finance INTRODUCTION: To understand capital markets and its functions it is important to delve into the concept of stock market efficiency. This concept deals with the movement in share price in the stock market and the factors affecting the movement…
Market efficiency is a crucial factor in deciding the investment strategies of an investor. If the securities market is efficient, the best estimate and returns will be reflected in the price of the shares and there will be no undervalued securities that would offer higher return than expected. However, opposite could be the case in the weak efficient markets. (WOOD, DASGUPTA & POSHAKWALE, 1995) THREE FORMS OF MARKET EFFICIENCY BY FAMA (1970): In this aspect the most contributing work was presented by Fama in 1970. He formulated a market efficiency hypothesis (EMH) which discussed the three types of market efficiency that can prevail in a capital market depending on the available information in the market. These three forms of market efficiency are (1) Weak form efficiency (2) Semi-strong form efficiency (3) Strong from efficiency. 1. Weak Form Efficiency: The weak form of market efficiency hypothesis asserts that the current stock price reflects all the information related to historical prices or past price movements only. This information includes trading volume, rate of return and market generated information etc. This form of market efficiency assumes that the current stock prices reflect all the past information and no one can earn huge profits by knowing information which is known to everyone in the market. This implies that the future rate of return can’t be predicted by using past rate of return and can’t provide with huge abnormal returns. In order to predict the movement of prices based on the past information a technique called technical analysis is sued widely. (BHOLE. 1982; CLARKE, JANDIK & MANDELKER, 2001) 2. Semi-Strong Form Efficiency: The semi-strong form of market efficiency hypothesis explains that the current stock price reflects all the publicly available information along with the historical information. The available public information includes: stock earnings and prices, declared dividends information, political, economy and company related news, dividend yield ratio, price earning ratios, announce merger plans, available information in company’s financial statements, financial situation of competitors and stock splits etc. The assertion behind this form of market efficiency is the same that no one can earn huge profits by knowing information which is known to everyone in the market that is the information is public. In this way the public information is already absorbed into market prices and the investors can’t yield above average profits in such investments and markets. (BHOLE, 1982; CLARKE, JANDIK & MANDELKER, 2001) 3. Strong form Efficiency: The strong form of market efficiency hypothesis explains that the currents stock price reflects all the available information including public and private information both. It encompasses both the weak and semi-strong form of markets. In this hypothesis the emphasis is on insider dealings. It implies that, when both public and private information is reflected in stock price, the directors or the bunch of individuals in the company who have more knowledge of the company will not be able to benefit from the above average profits. The difference between semi-strong and strong efficiency is that in a strong efficiency market nobody will benefit from the information that ...
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