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What are the three forms of Capital Market Efficiency?
Capital Market Efficiency indicates the degree to which the present stock prices accurately reflect the current information available in the marketplace. There are three basic forms of capital market efficiency: weak form, semi-strong form, and strong form.
Weak Form of Capital Market Efficiency
In a weak capital market, only the past information of security is available. That means the weak form of capital market efficiency offers a limited window to view the future trends of a share price. It is not possible for analysts to predict the future prices of a share by following the capital market indices. It happens due to the fact that the markets do not have memory and the stock market index has already included the information about the securities.
The correlation of security prices over time offers a view of the efficiency of the market in its weak form. It is observed that there is a randomness in the share prices in a weak form of the capital market. That is why the weak form of capital market is also called the random walk hypothesis.
Semi-strong Form of Market Efficiency
In semi-strong form, the securities usually reflect all information that is publicly available. This information can be obtained from credible business sites or publications. Therefore, an investor cannot outperform the market by following the available information, as it has already been applied and processed in the market.
In order to establish the fact that a capital market is semi-strong one has to go for event studies. Studying the effects of events, such as earnings, bonus issues, dividends, and changes in accounting practices, one can justify the strength of the capital market. For example, by studying how fast the market reacts to a dividend payout, one can understand the speed of adjustment of the information.
The semi-strong event hypothesis stresses that the market uses the event information very quickly and investors cannot beat the market using such information.
Strong Form of Efficiency
In strong form of market efficiency, analysts and investors have access to all published and non-published forms of information. There have been no empirical studies on the effectiveness of a strong form of market efficiency.
It has been generally observed that investors with insider knowledge have sometimes outperformed the market in a capital market in its strong form.
The theory of capital market efficiency is useful in determining the nature of share-price movements and it has been used by investors for a long time. However, irrespective of the nature and status of the form of a capital market, investors have found it tough to determine the possible movements of the share price in the future. Although sometimes, the investors in strong markets have got a grip on the share price movements, it has not been possible to realize the trends in other forms.
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