MARKET EFFICIENCY

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There is a lot of talk about the “efficient capital market”. Market efficiency describes the operating characteristics of the capital market.

These are of two types:

1. Operationally or internally efficient. In which an investor can do transactions as cheaply as possible. This would include brokerage, commissions, and other charges.

2. Pricing or externally efficient. In which an investor can expect that stock prices at all times reflect all available information that is relevant to the evaluation of the stocks.

When the market is price efficient, active portfolio strategies would not produce superior returns after adjusting for risk, transaction costs and advisory charges.

Further market efficiency are of 3 forms: weak, semi strong and strong.

1. Weak efficiency means that the price of the securities fully reflect price and trading history.

2. Semi strong efficiency means that the price of securities fully reflects all public information, including historical price and trading patterns.

3. Strong efficiency means that the prices of securities reflect all information regardless of whether or not it is publicly available, including historical price and trading patterns.

The evidence shows that in India and in other markets across the globe the equity market efficiency exists in its semi-strong form. Although some would argue that it is strong in nature.

While investigating efficiency we should examine the following questions:

Do some market participants have superior forecasting ability?
Do fund managers consistently outperform the market?
Are there arbitrage trading opportunities available?
Does the market use all publicly available information to value a security?

Answers to the above questions would indicate the existence of semi-strong market efficiency in our markets.

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