Economic Theory Suggests That Markets Are Efficient and Security Prices Are Determined on the Basis of Fundamental Value
¡§Economic Theory Suggests that Markets are Efficient and Security Prices are Determined on the Basis of Fundamental Value¡¨
Market efficiency requires that security prices react immediately in an unbiased way to the receipt of new information (Robert Shiller S1998). In other words, an efficient capital market is one in which stock prices fully reflect available information. In addition, there are three conditions for market efficiency; information flows freely, market is composed of rational investors where all competing against each other with the objective of maximizing wealth and there is no market imperfections. In efficient market, investors actively compete in the market based upon perceived mispricing derived from an analysis of available information. In such a world, prices are soon driven to their fair value or to a level where investors are unable to identify stocks whose prices are at variance with fair value. Therefore, investors cannot consistently generate returns over and above the level necessary to compensate for the inherent risks of the investments. Given the statement that economic theory suggests markets are efficient and security prices are determined on the basis of fundamental value; all publicity information should reflect onto the stock prices. Nevertheless, the theory of market efficiency faces several arguments.
Rationality: Is all or most investors rational? In fact, many investors do not achieve the degree of diversification that they should. Others trade frequently, generating both commissions and taxes. Many are more likely to sell their winners than their losers, a strategy leading to high tax payments. Irrational investor will continue to buy overprice stocks and causes further disparity from its fair price (Werner F. M. De Bondt and Richard H. Thaler WDT 1994).
Practice of investment strategies: Research done by Ron Bird 2005 shows that the markets are becoming less efficient with changes in the composition of investors
Market efficiency requires that security prices react immediately in an unbiased way to the receipt of new information (Robert Shiller S1998). In other words, an efficient capital market is one in which stock prices fully reflect available information. In addition, there are three conditions for market efficiency; information flows freely, market is composed of rational investors where all competing against each other with the objective of maximizing wealth and there is no market imperfections. In efficient market, investors actively compete in the market based upon perceived mispricing derived from an analysis of available information. In such a world, prices are soon driven to their fair value or to a level where investors are unable to identify stocks whose prices are at variance with fair value. Therefore, investors cannot consistently generate returns over and above the level necessary to compensate for the inherent risks of the investments. Given the statement that economic theory suggests markets are efficient and security prices are determined on the basis of fundamental value; all publicity information should reflect onto the stock prices. Nevertheless, the theory of market efficiency faces several arguments.
Rationality: Is all or most investors rational? In fact, many investors do not achieve the degree of diversification that they should. Others trade frequently, generating both commissions and taxes. Many are more likely to sell their winners than their losers, a strategy leading to high tax payments. Irrational investor will continue to buy overprice stocks and causes further disparity from its fair price (Werner F. M. De Bondt and Richard H. Thaler WDT 1994).
Practice of investment strategies: Research done by Ron Bird 2005 shows that the markets are becoming less efficient with changes in the composition of investors