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5. Market Efficiency Notes

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This is an extract of our 5. Market Efficiency document, which we sell as part of our Corporate Finance Notes collection written by the top tier of University Of London (examined By LSE) students.

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Market Efficiency
Efficiency Markets: Theory and Empirical Evidence
Efficient Market Hypothesis
The ability to make excess returns based on a certain info set (  )
Jensen (1978)
'A market is said to be efficient with respect to a given info set  if no agent can make economic profit through the use of a trading rule based on . Economic profit is defined as the level of return after costs are adjusted appropriately for risk.'
T = Set of info available at time T for determining prices at Time T
TM = Set of info used by the market to determine prices at Time T
Efficient market: T = TM
Characteristics of Efficient Market
 Prices fully reflect all available information
 Prices at any time are determined correctly according to all available information
 Prices react to new info quickly and correctly
 Excess return cannot be earned by trading on the basis of information
Fama (1991)

Characteristics
 Prices fully reflect all historical info
 Historical info fails to predict price changes

Weak-form
Efficiency

 Excess returns cannot be earned with only historical info
 Technical analysis does not work
 Fundamental analysis may work
 Prices follows the random walk model
 Autocorrelation of returns = 0
 Prices fully reflect all public info
 Public info fails to predict price changes

Semi-strong-form
Efficiency

 Excess return cannot be earned with only public info
 Technical analysis does not work
 Fundamental analysis does not work
 Private information can provide excess returns

Strong-form
Efficiency

 Price fully reflect all public and private information
 All sort of info fails to predict price changes

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