Chapter 1: Efficient Market Hypothesis Flashcards
Efficient security market
One in which the price of every security fully reflects all available information; i.e. = “true” investment value.
3 Forms of market efficiency
- Strong form
- Semi-strong form
- Weak form
Strong form EMH
Market prices reflect all information; whether or not publicly available
Semi-strong form EMH
Market prices reflect all publicly available information
Weak form EMH
Market prices reflect all info from historical price data.
Importance of market efficiency
If markets are inefficient, then investors with better information may be able to obtain higher investment returns.
Insider trading
Trading on the basis of privileged information that is not publicly available.
Active fund management
Active fund managers attempt to detect exploitable mispricings.
Passive fund management
Passive fund managers simply aim to diversify across a whole market.
Explain why it is not straightforward to identify when the SEMI-STRONG EMH holds.
- Different stock exchanges have different levels of disclosure & hence, different levels of efficiency.
- Even if information is publicly available, there is a cost and possibly a time delay to obtain it. This erodes the advantages of obtaining information.
- Individuals do not have access to the management of companies that fund managers do. They spend time & money interviewing senior management.
Comment on the implications of stock market efficiency for active & passive fund managers
In aggregate, active managers hold the market, which is identical to the passive manager. Therefore the average active manager should perform in line with the passive manager.
If markets are inefficient, we would expect active managers with above-average skill to perform better than passive managers.
The existence of active managers suggests a belief that markets are inefficient.
