The purpose of the capital market is the efficient reallocation of funds between investors and borrowers. Individuals and firms may have excess capacity to invest in production but do not have sufficient funds to use them all for their purposes (Renshaw, 1984). If the capital market exists, they can borrow the money they need(Renshaw, 1984). Thus, both investors and borrowers gain benefits if efficient capital markets facilitate the reallocation of funds.
The Efficient Market Hypothesis (EMH) assumes that all market trends at the current moment are instantly reflected in the stock quotations; weak, semi-strong, and strong forms reflect the market efficiency. In the strong form, current share prices consider all information obtained from private and public sources (Hensoldt, 2017). It might be the most efficient form, but all real-life financial markets are far from efficient (Hensoldt, 2017). However, there is some criticism of the idea of EMH; people perceive market information differently, and the participants can start panicking (Hensoldt, 2017). Investors believing in the EMH may rely on the fact that panic is recognized and corrected promptly (Renshaw, 1984). Finally, investor decisions are not always based on public or private information; instead, they depend on their risk tolerance level.
Reference List
Hensoldt, A. (2017) ‘Pragmatic theory of information and the efficient market hypothesis: From philosophical ideas to traders’ behavior analyses’, In Stickers, K.W. and Skowroński, K.P. (eds.) Philosophy in the Time of Economic Crisis. London: Routledge, pp. 125-140.
Renshaw, E. F. (1984) ‘Stock market panics: A test of the efficient market hypothesis’, Financial Analysts Journal, 40(3), pp. 48–51.