Stock Market Efficiency

Fama (1970) identified 3 forms of efficiency: weak form efficiency, semi-strong form efficiency and strong form efficiency. In term of weak form efficiency, current share prices reflect all past movements and there will be no mechanical trading rules based on past movements which will generate profits in excess of the average market return. While in semi-strong form efficiency, share prices not only reflect all historic and publicly available information, but also react quickly and rationally to new information. It can’t make abnormal returns by studying publicly available information. Finally, in strong form efficiency, share price reflects all information including publicly available or not, and no one can make abnormal returns.

Using Fama’s idea, it is easy understood that Apple inc share price decrease promptly when it announced its financial report on January 24 that gross margin increase slowly. It can be seen that their share price fall successively in next two days. This instant reaction to new information is evidence of the New York Stock Exchange being a semi-strong form when it comes to market efficiency.

           

Kendal (1953) found that prices changed in a random fashion. There is no systematic link between one price movement and subsequent ones. In addition, share prices at any time reflect all known information and changes occur when new news enters the market. According to this argument, the analyst work is meaningless due to the share price is unforcastable. It also challenges to the significance of investment companies like Morgan Stanley and Goldman Sachs.

Reference

Fama, Eugene (1970). “Efficient Capital Markets: A Review of Theory and Empirical Work”, Journal of Finance, 25, pp. 383-417

Kendall, M. G.; Bradford Hill, A (1953). "The Analysis of Economic Time-Series-Part I: Prices". Journal of the Royal Statistical Society. Series A (General) (Blackwell Publishing) 116 (1): 11–34