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Efficient Capital Markets

Efficient Capital Markets. Prices in informationally efficient capital markets reflect all available information. To outperform the market, we need to find and exploit inefficiencies. The Efficient Markets Paradox.

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Efficient Capital Markets

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  1. Efficient Capital Markets • Prices in informationally efficient capital markets reflect all available information. • To outperform the market, we need to find and exploit inefficiencies. CFALA/USC CFA Review Level 1, SS-13

  2. The Efficient Markets Paradox If prices were truly efficient, no one could profit from research so none would be done. If no one traded on research, prices would not be efficient. CFALA/USC CFA Review Level 1, SS-13

  3. Resolution of the Paradox • Prices are not always fully efficient. • Informed traders profit when securities are mispriced. • Securities are mispriced when • Values change • Uninformed traders cause prices to change. • Informed traders profit to the extent of their informational advantage. CFALA/USC CFA Review Level 1, SS-13

  4. a. define an efficient capital market and describe and contrast the three forms of the efficient market hypothesis (EMH); Efficient Capital Markets • An efficient capital market is one in which security prices adjust rapidly to the arrival of new information so that current securities prices of securities reflect all available information. • New information is unexpected information. CFALA/USC CFA Review Level 1, SS-13

  5. Who Makes Markets Efficient? • Speculators compete to profit from unique information and analytic insights into security values. • Well informed traders buy when prices are below fundamental value. Their buying pushes prices toward fundamental value. • Likewise for selling. CFALA/USC CFA Review Level 1, SS-13

  6. The Efficient Markets Hypothesis Prices reflect all available information about security values. Three forms of the EMH condition on different sets of available information. CFALA/USC CFA Review Level 1, SS-13

  7. … describe and contrast the forms of the efficient market hypothesis (EMH)… The Three Forms of the EMH • Weak: market information, such at historical sequence of prices, trading volume, odd-lot transactions, etc. • SemiStrong: all public information including public information about earnings, new products, political conditions, and market conditions. • Strong: all public and private information. Private information includes insider information and privately acquired data and analyses. CFALA/USC CFA Review Level 1, SS-13

  8. Semi-Strong Form All Public Information Weak Form Security Market Information Market Efficiency Public and Private All Information Strong Form CFALA/USC CFA Review Level 1, SS-13

  9. The Three Forms of the EMH Here’s how I remember it: If Weak form is true: Technical traders/chartists can’t win. If SemiStrong form is true: CFAs can’t win. If Strong form is true: Illegal insider traders can’t win. … describe and contrast the forms of the efficient market hypothesis (EMH)… 9 CFALA/USC CFA Review Level 1, SS-13

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