In economic theory, there is a concept of market efficiency; the Efficient Market Hypothesis (EMH) is one of the basic ideas of finance theory. There are three forms of market efficiency: weak, semi-strong and strong. The criterion of efficiency is determined by the access of its participants to information. The completeness of the information regarding the asset price is a crucial factor in ENH; thus, it is important to analyze three forms of market efficiency.
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Weak Form Efficient
The weak form of market efficiency occurs if the value of an asset fully reflects the related information. Therefore, if the state of the market corresponds to such a form, the analysis of past information becomes unnecessary since it has already been reflected in the price. Past information is primarily data analyzed in the framework of technical analysis. An analyst with data on market prices can identify trends and predict their behavior in the future through analysis (Sadat and Hasan, 2019, p. 411). However, in a weak form of market efficiency, technical analysis is a useless tool (Sadat and Hasan, 2019, p. 411). In this case, the movement of market prices is random, and the investor will not be able to consistently make a profit in the long term, basing their actions on the results of technical analysis.
Semi Strong Form
The semi-strong form of efficiency assumes that the price of an asset reflects not only past but also public information. Such a form allows businesses to get excess profits through the use of public information, including data from fundamental analysis. Since all market participants simultaneously receive publicly available information, none of them will receive additional income through fundamental analysis (Jethwani and Ramchandani, 2017, p. 2349). In addition, there might be insiders in such a market – individuals with access to private information, such as the CEO and board members. Due to their advantage in access to information over other market participants, they can get a significantly higher profit than that shown by the line of the securities market.
A strong form of efficiency appears when the price of an asset reflects all information: past, public and private. With a strong form of market efficiency, it is impossible to obtain extra benefits using inside information since it has already been taken into account in the price of a financial asset (Alajbeg, Bubas and Sonje, 2012, p. 57). This form of market efficiency does not exist in real life since, in actual markets, the legislation contains specific barriers that prevent private information from getting into the public domain. Moreover, legislation, as a rule, creates a number of regulations that prevent insider trading.
Nevertheless, EMH has been criticized from the perspective of applicability of the theory in practice. According to Dhir (2018), “since investors value stocks differently, it is impossible to ascertain what a stock should be worth under an efficient market.” The concept of market efficiency has been analyzed in terms of market anomalies that contradict this hypothesis. The day-of-the-week effect is discovered: the profitability of a financial instrument on Monday is usually less than on other days of the week (Alajbeg, Bubas and Sonje, 2012, p. 61). The effect has been seen in the stock, money and futures markets. Another anomaly is that the profitability of small firms is more significant than that of large ones compared to their level of risk (Malkiel, 2003, p. 67). In my opinion, after businesses post quarterly profits, it is possible to make additional profits by buying stocks in companies with good performances. It is also possible to sell stocks in companies with poor performances, as the trend backed by such information persisted for some time.
Overall, if the market is efficient, then all investors are in equal competitive conditions in relation to each other. A significant change in the price of an asset can only be caused by the appearance of any new information that could not be predicted with a sufficient degree of reliability in advance. Therefore, the data is not taken into account in the price. At the same time, the particular anomalies are likely to be regarded as solid arguments in favor of refuting weak and semi-strong forms of market efficiency.
Alajbeg, D., Bubas, Z. and Sonje, V. (2012) ‘The efficient market hypothesis: problems with interpretations of empirical tests’, Financial Theory and Practice, 36(1), pp. 53-72
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Dhir, R. (2018) ‘Efficient market hypothesis: is the stock market efficient?’. Investopedia.
Jethwani, D. and Ramchandani, K. (2017) ‘Semi strong form of efficiency of the stock market: a review of literature’, International Multidisciplinary Research Journal, 4, pp. 2349-7637.
Malkiel, B. G. (2003) ‘The efficient market hypothesis and its critics’, The Journal of Economic Perspectives, 17(1), pp. 59-82.
Sadat, A. R. and Hasan, M. E. (2019) ‘Testing weak form of market efficiency of DSE based on random walk hypothesis model: a parametric test approach’, International Journal of Accounting and Financial Reporting, 9(1), pp. 400-413.