Trading Glossary | interactive investor
The research on market efficiency includes a wide array of quantitative and mathematical analysis, along with behavioural studies. This paper, however, does not focus on the mathematical analysis itself, but the results and the conclusions of the various researches. The paper will begin with a brief background on the definition of efficiency, including the various forms of efficient markets. It will use the groundbreaking research paper by Fama, written in 1970, to discuss the proposed degrees of market efficiency. The paper will later discuss the various academic and professional views on the efficient market hypothesis (EMH) and the degree of the market efficiency. Finally, the paper will combine the various academic and professional findings and analyze these studies to conclude on the degree of the market efficiency.
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There are some academics that disagree with the semi-strong market efficiency. Fugate describes in his paper entitled “” (1997) that the market is not semi-strong efficient as previously thought. Fugate conducted his research on the initial public offerings for mutual thrift institutions from January 1, 1992 through August 31, 1994. There were a total of 133 observations, however 30 were randomly chosen. Prices were collected at different time intervals after the initial public offering to determine the response rate of the market. He recorded that there was under-pricing in the IPO and the share prices changed for the entire 30 days after the IPO till they reached the correct price. This research refutes the semi-strong form market efficiency because the stock prices should have been adjusted automatically (and efficiently) to the right price instead of drifting (Fugate, 1997). In the study, , Liang agrees with lack of semi-strong market efficiency. He describes that the drift that results due to overconfidence in private information, and overconfidence/under-confidence in more reliable information, therefore leading to incorrect stock prices. He uses behavioural finance to discuss that there is an overreaction to news, and stock prices do not efficiently adjust to the new prices, and there is considerable evidence of price drifting. He used the one, and two year earnings forecast for 3,335 different firms from January 1989 to December 2000 and forecasts by the analysts to determine earnings surprises. He used OLS regression to determine whether there is statistical significance and found that there is considerable amount of drift present in the stock market, and the stock market is not semi-strong efficient (Liang, 2003).
The studies reviewed here strongly approve of the weak-form of market efficiency, however there are mixed reviews over the various studies about semi-strong market efficiency. The study of the various research papers by academics have proved that the market shows signs of semi-strong efficiency only in certain cases, such as stock splits, dividend announcements, mergers and acquisitions, and initial public offerings. However, time-series and cross-sectional tests give a different picture that the market do not conform to semi-strong. Finance professionals add on by saying that EMH holds in certain cases, however the recent bubbles dictate that the market may not be semi-strong efficient. The paper concludes that the market lies somewhere between weak and semi-strong form efficiency. However, this area of finance requires a lot more research to better understand the true market efficiency.