TOPIC 5: MARKET EFFICIENCY, EXCHANGE RATE
FORECASTING AND DETERMINATION
5.1: MARKET EFFICIENCY HYPOTHESIS
An efficiency market is one in which the prices of traded securities readily
incorporate new information. Numerous studies of foreign capital markets have
shown that traded securities are correctly priced in that trading rules based on
past prices or publicly available information cannot consistently lead to profit
(after adjusting for transactions cost) in excess of those due solely to risk trading.
Features of efficiency capital market
The capital market can be judged on three measurement or features:-
(a) Operational efficiency- transaction costs in the market should be low and
trading should be quickly effected. The low transaction costs and low
brokerage fees will encourage a greater volume of shares dealing and should
help to encourage allocate efficiency.
(b) Pricing efficiency:- this is also termed as efficiency at processing
information.
The prices of capital market securities fully and fairly reflect all information
concerning past events and all events the market expects to occur in the future.
This is so, because even investors who do not have access to information can be
confident that when they buy or sell quoted securities, they do so at a fair price.
If the market is relatively slow at reflecting new information then some investors
who have access to the information will gain at the expense of those who do not
have.
(c) Allocation efficiency
This means the capital market through the medium of pricing efficiency,
allocates funds to where they can best be used. A market shows allocative
efficiency if it channels savings towards those firms, which are most productive.
, Forms/ levels of market efficiency
To explore the meaning of information processing efficiency further we need to
examine three cases of so called efficiency market hypothesis:
(a) Weak form efficiency.
This states that all information contained in historical prices and firm
characteristics (such as size, book value etc.) is incorporated in the actual
(current) price. All historical information is thus reflected in the observed
market price.
Current share price reflect all information about previous share prices.
Knowledge of the previous price is of no help in predicting future prices i.e.
Chartism is not helpful. It is not possible to make abnormal returns by studying
past. Share price movement can’t be made by technical analysis.
Notice that, no claim is made about the inclusion of any other type of
information, nor about the speed with which information is incorporated in asset
prices.
(b) The semi-strong form of efficiency.
This includes the history of past prices as well as all publicly available
information about assets’ returns, i.e. all disclosures, announcements and reports
which are available to all market participants. All such information is reflected in
the current price.
This postulates that current share prices fully reflect not only historical
information but also all other publicly available information. Consequently it
should be impossible to make consistent abnormal gains by examining public
information such as published accounts, dividends declaration, and public
statements by directors.
(c) The strong form of efficiency
In addition to the above, the strong form of the EMH also includes all privately
available information on the assets, i.e. information proprietary to particular
analysts and managers. The most common such information is private forecasts
of asset returns.
FORECASTING AND DETERMINATION
5.1: MARKET EFFICIENCY HYPOTHESIS
An efficiency market is one in which the prices of traded securities readily
incorporate new information. Numerous studies of foreign capital markets have
shown that traded securities are correctly priced in that trading rules based on
past prices or publicly available information cannot consistently lead to profit
(after adjusting for transactions cost) in excess of those due solely to risk trading.
Features of efficiency capital market
The capital market can be judged on three measurement or features:-
(a) Operational efficiency- transaction costs in the market should be low and
trading should be quickly effected. The low transaction costs and low
brokerage fees will encourage a greater volume of shares dealing and should
help to encourage allocate efficiency.
(b) Pricing efficiency:- this is also termed as efficiency at processing
information.
The prices of capital market securities fully and fairly reflect all information
concerning past events and all events the market expects to occur in the future.
This is so, because even investors who do not have access to information can be
confident that when they buy or sell quoted securities, they do so at a fair price.
If the market is relatively slow at reflecting new information then some investors
who have access to the information will gain at the expense of those who do not
have.
(c) Allocation efficiency
This means the capital market through the medium of pricing efficiency,
allocates funds to where they can best be used. A market shows allocative
efficiency if it channels savings towards those firms, which are most productive.
, Forms/ levels of market efficiency
To explore the meaning of information processing efficiency further we need to
examine three cases of so called efficiency market hypothesis:
(a) Weak form efficiency.
This states that all information contained in historical prices and firm
characteristics (such as size, book value etc.) is incorporated in the actual
(current) price. All historical information is thus reflected in the observed
market price.
Current share price reflect all information about previous share prices.
Knowledge of the previous price is of no help in predicting future prices i.e.
Chartism is not helpful. It is not possible to make abnormal returns by studying
past. Share price movement can’t be made by technical analysis.
Notice that, no claim is made about the inclusion of any other type of
information, nor about the speed with which information is incorporated in asset
prices.
(b) The semi-strong form of efficiency.
This includes the history of past prices as well as all publicly available
information about assets’ returns, i.e. all disclosures, announcements and reports
which are available to all market participants. All such information is reflected in
the current price.
This postulates that current share prices fully reflect not only historical
information but also all other publicly available information. Consequently it
should be impossible to make consistent abnormal gains by examining public
information such as published accounts, dividends declaration, and public
statements by directors.
(c) The strong form of efficiency
In addition to the above, the strong form of the EMH also includes all privately
available information on the assets, i.e. information proprietary to particular
analysts and managers. The most common such information is private forecasts
of asset returns.
