Market Efficiency In The Presence of Extermalities - Essay Example

Most positive economists admit the existence of barriers to competition. As such markets are incomplete given the imperfect information relayed to the consumer. Nevertheless, general equilibrium analysis is often utilized to as a theoretical tool to approximate reality. Market efficiency is rather a controversial concept that has attracted strong views, partly in regards to differences about what it really means on one hand, and on the other hand on investor approaches to investing. It is an economic concept that investigates the effects of allocation of scarce resources towards the well-being of the entire participant within a given economy.

An efficient market is a market scenario where commodity prices reflect all information available (Fama 383). The degree of efficiency lies in the type if information incorporated into the prices and the speed with which such information are reflective of the market prices (Jensen 96). The question as to whether markets are or are not efficient is central to investment decisions. In a scenario where markets are efficient, commodity price signals provide the best investment appraisal criteria, and the appraisal process itself justifies the market price levels.

Under circumstances of inefficient markets, commodities prices deviate from their true values, and the process of investment appraisals utilizes approximate bench marks in obtaining the viability of investment decisions. Valuation under efficient market conditions yields ‘higher’ returns to certain investors, given the capacity to spot mistakes of under-valuing or over-valuing investment decisions (Fama 396). In essence, an efficient market condition is one in which market prices are reflective of true estimates of investment decisions (Jensen 101).

Implicitly, and contrary to the popular view, efficiency of markets does not imply that commodities prices prevailing in the market must equal the true value at all time. All that is needed are unbiased commodities prices, that is to say, prices can randomly deviate from their true value. Under these circumstances therefore, no one group of investors should consistently, with certainty, find their investment strategy running in tandem with market prices. As stated above, the definitions of market efficiency are linked up with information available to investors that are subsequently reflected in commodity prices.

Strictly speaking, market efficiency assumes perfect information, for the public and private investors, which is then reflected in the market prices. This implies that investors with precise information on the running of the market will be able to beat the market inefficiencies (Fama 402). Given that the specificity which market efficiency is defined, it is extremely unlikely that markets will be efficient to all investors always. However, it is very possible that a given market (for example the New York Stock Exchange) will be efficient with regards to an average investor.

The possibilities and the impossibilities also extend to certain markets as well as to different investors. This is because tax rates are different in different markets scenarios, and so are the costs of business transactions, which confer competitive advantages on certain investors relative to others. In essence, no group of investors can consistently utilize a common investment strategy and emerge victorious. There has to be variations with elements of lose to one or two