Investment

SELECTED TUTORIAL ANSWER

CHAPTER 6

24.

24(a). Efficient market hypothesis (EMH) states that a market is efficient if security prices immediately and fully reflect all available relevant information. Efficient means informationally efficient, not operationally efficient. Operational efficiency deals with the cost of transferring funds. If the market fully reflects information, the knowledge that information would not allow anyone to profit from it because stock prices already incorporate the information.

1. Weak form asserts that stock prices already reflect all information that can be derived by examining market trading data such as the history of past prices and trading volume.

Empirical evidence supports the weak-form.

A strong body of evidence supports weak-form efficiency in the major U.S. securities markets. For example, test results suggest that technical trading rules do not produce superior returns after adjusting for transaction costs and taxes.

2. Semi-strong form says that a firm’s stock price already reflects all publicly available information about a firm’s prospects. Examples of publicly available information are annual reports of companies and investment data.

Empirical evidence mostly supports the semi-strong form.

Evidence strongly supports the notion of semi-strong efficiency, but occasional studies (e.g., those identifying market anomalies including the small-firm effect and the January effect) and events (e.g., stock market crash of October 1987) are inconsistent with this form of market efficiency. Black suggests that most so-called “anomalies” result from data mining.

3. Strong form of EMH holds that current market prices reflect all information, whether publicly available or privately held, that is relevant to the firm.

Empirical evidence does not support the strong form.

Empirical evidence suggests that strong-form efficiency does not hold. If this form were...