This lesson explains what it means for a stock market to be efficient, how operational efficiency differs from informational efficiency, and how the three forms of the efficient market hypothesis classify the information reflected in stock prices.
An efficient market is one in which transaction costs are minimal and prices are current and fair to market participants. For investors, two practical questions help clarify the idea: Can an order be completed quickly at the best available price, and do prices reflect the information available to traders?
All flashcards
Efficient market
A market aiming for minimal transaction costs and current, fair prices, with effective trade execution and information reflected in prices.
Operational efficiency
The speed and accuracy with which a market processes orders and executes trades at the best available price.
Informational efficiency
How quickly and comprehensively available information is reflected in market prices.
Semi-strong-form efficiency
The claim that prices reflect all publicly available information, including historical trading data and public announcements.
Strong-form efficiency
The claim that prices reflect all relevant public and private information.
Quiz questions
What does informational efficiency describe?Answer: How quickly and fully available information is reflected in market prices.
Under semi-strong-form efficiency, what follows for investors analyzing public financial statements and news?Answer: They cannot consistently earn risk-adjusted returns above the market using that information.
How are the three forms of the efficient market hypothesis related?Answer: Each stronger form includes the information set covered by the preceding form.
Which statement is not implied by market efficiency?Answer: Every market price is guaranteed to be correct in hindsight.
What is a stale price or quote in a financial market?Answer: An outdated price or quote that may not reflect newer information.
Based on Principles of Finance by Julie Dahlquist, Rainford Knight (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.