Name: Shi Yu
Tutor: Ho Ming Lawrence FUNG
Definition of efficient market:
The efficient market is defined as a market where competition among investors should work to eliminate all positive-NPV trading opportunities or, equivalently, that securities with equivalent risk should have the same expected return based on their future cash flows, given all information that is available to investors.
Definition of arbitrage:
It is known as the practice of buying the low-priced goods and selling them at higher prices in different markets or in different forms to gain the guaranteed profit with no risk involved.
Definition of three forms of market efficiency:
There are three commonly defined forms in which the efficient market is stated: weak-form efficiency, semi-strong-form efficiency and strong-form efficiency. Weak-form efficiency claims that all past prices of a stock should be reflected in the stock’s current price and thus making it impossible to profit by trading on information in past prices in the long run. Semi-strong efficiency states that share prices should adjust to publicly available new information instantaneously in an unbiased fashion. Therefore no excess returns can be consistently earned by trading on any public information. In strong-form efficiency, the aggregated information in a market, whether public or private, has been taken into account in share prices. Profits exceeding normal returns should not be possibly realized consistently, regardless of any information that investors have access to.
Explanation of difference between each form and perfect market: The common difference might be that: while in a perfect market each participant is assumed to earn normal profits or, equivalently, that competitors’ returns could be regarded as uniformly distributed in the case of identical goods, a non-uniform distribution may emerge in an efficient market, that is to say,...