Testing for market efficiency in a set of processes, data and KPIs and a the global team it is gonna work for all businesses around the world.

“Clearly, no stock market anywhere in the word is a perfect market. “

However, companies and investors do not need capital markets to be perfect; rather, they need capital market to be efficient and to offer fair prices so they can make reasoned investment and financial decisions.

In corporate finance an efficient market points out three form test to this matter:

1. Strong form test

Because some people have access to information before other investors and so can make abnormal gains, it can be argued that capital markets are not strong form efficient.

It is not possible to test for strong efficiency directly by investigating market’s use of insider information, since by definition this information is unknown.

Test from strong form efficiency are therefore indirect in approach

They examine how expert users of information is unknown. Test for strong form of efficiency are therefore indirect approach: they examine how expert users of information perform when compared against a yardstick such as the average return on the capital market.

“Fund managers with resources to invest in discovering and analysing information may be in a better position than most to make abnormal gains.”

If their funds achieved above-average performances ona regular basis, this would be the evidence that capital markets are not strong form efficient.

A classic study of 115 mutual fund that the majority did make above-average returns when management costs were taken into account: in fact, their performance was inferior to a passive buy-and-hold strategy as Jensen sustained.

Research continues to show that actively managed funds underperform the market after accounting for management costs, and in many cases before accounting for management costs as well.

It has also been shown that investors could not benefit from the investment advice of financial tipsters(insider information becoming public information) due to the speech with which the market factored new information into share prices.

2. Semi-strong form tests

Tests for semi-strong form efficiency look at the speed and accuracy of share price responses to new information(event studies). In general, event studies support the view that capital markets are semi-strong form efficient.

As examination of the adjustment of share prices to the release of information about share splits found it was not possible to profit from the information because the market seemed to incorporate it efficiently and effectively. Similar findings were reached regarding earnings announcements, and merger announcements in Keon and Pinkerton advice.

While event studies support the semi-strong form of efficient market hypothesis, they also offer evidence of anomalies, such as the observation that share prices continue to rise(or fall) for a substantial period following the release of positive (or negative) information. It has also been found that the more frequently a share is traded, the shorter the time required for its price to return to equilibrium having absorbed new information.

3. Weak form test

If a capital market is weak form efficient, so that share prices reflect completely all past information, it will not be possible for investors to predict future share prices by studying past share price movements. Share prices will change as new information arrives on the market and, since new information arrives at random, share price movements will also appear to be random.

Many empirical studies have supported the proposition that the movement of share prices over time represent a random walk. This random walk hypothesis suggests that, if we know the share price at the end of one time period , we cannot predict accurately the share price at the end of the next period.

Empirical evidence strongly supports the view that the relationship between share prices in different period on well-developed capital markets is random, in which case we can say that research shows that:

Well-developed capital markets are weak form efficiency have used serial correlation tests, run tests and filter tests.”

One of the earlier studies testing for serial correlation looked for any correlation between security price changes at different points in time.

Studies using run tests examine whether any significance can be attached to the direction of price changes by examining the length of the run of successive price changes of the same sign.

The empirical evidence indicated that the direction of prices changes on any one day was independent of the direction of price changes on any other day.

The distribution of direction was found to be based on pure chance, adding further support to the view that capital markets are weak form efficient filter tests try to identify any significant long-term relationships in security price movements by filtering out short terms price chnages.

One early study found that white filter tests could provide abnormal returns compared with a simple buy and hold strategy, gains were cancelled out when transactions costs were taken into account.

More recent studies have found weak evidence that a period of above average returns may follow a long period of below average returns (mean reversion), buy the weak form of the efficient market hypothesis is still broadly supported.

It also have been argued from an insider perspective that trading strategies based on anomalies do not generate abnormal returns.

Recent reasearch has indicated that emerging capital markets may be weak form inefficient with lower levels of liquidity and turn oner associated with such markets suggested as contributory factors.


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