chapter 12

Market Efficiency

Having considered the issue of market equilibrium, it occurs to you that while it is relatively easy to discuss, it may be simply that—talk! What matters is how quickly markets digest information, and how well and quickly stock prices reflect information. You have heard some people say investors can beat the market with the right techniques because there are market inefficiencies, while others say the market is efficient and most investors cannot beat the market. You even recall someone telling you about the January effect. So who is right?

With a little reflection, you realize you could end up wasting a lot of time if you employ techniques to pick stocks that have been shown to be of little or no value—and people are always selling a wide variety of services which claim to aid investors in picking stocks. On the other hand, if there really are some apparent exceptions to market efficiency, it could pay to know about them. Also, you have now heard some talk about behavioral finance, which suggests psychology plays a role in investor actions, which would seem to imply that investors may not always be acting “rationally.” Therefore, it seems logical to you to consider this whole issue of market efficiency.

Chapter 12 considers the question of how quickly and accurately information about securities is disseminated in financial markets; that is, how effectively are investor expectations translated into security prices? In a perfectly efficient market all ...

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