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What is Capital Market Efficiency?
It is observed that in most of the hypotheses of dividends and shares, analysts consider the capital markets to be efficient. However, from the point of view of an investor, there are no markets in the world that can be regarded as perfectly efficient. In fact, it is hard to define a perfectly efficient capital market. However, the efficiency of capital markets can be determined by incorporating some aspects of the capital market attributes.
In general, capital markets are envisioned to have enough liquidity and fair price mechanism.
Liquidity measures mean that the market can offer cash in lieu of securities instantaneously to the investors.
A fair price mechanism means that the markets are able to offer the optimum price of a share to shareholders at any given moment.
When the above two factors are considered in case of a capital market, the attributes of a share market become relevant. In fact, a capital market that has securities that can obtain prices derived out of demand and supply is considered the fairest.
Capital market efficiency is described as the quality of the securities to absorb the market conditions, reflect the effects on it and incorporate all of the relevant information instantaneously. It means, in an efficient capital market, the price of shares is adjusted to its best level automatically depending on the nature and environment of the market.
Although the concept capital market efficiency is easy to understand, the markets need to behave and act in a certain manner to maintain market efficiency. For example, an efficient capital market must provide all the information about securities to all participants without any bias. This is easier said than done because there several thousands of shares at any given moment in the market.
Capital market efficiency has its own advantages. For example, shareholders can invest money in an efficient share market without having to doubt the information provided by the market. This helps the investors put in more money in the market than when the efficiency of the market is compromised.
Capital market efficiency is a term related to the condition of the capital market where all the information is available for every participant and where securities can reflect and incorporate the necessary information in its fair pricing.
It is however tough to find a 100% efficient market because most of the shares in a capital market have randomness and all the necessary information may not be relevant at all moments in the market. However, the idea of capital market efficiency offers a window to devise many financial concepts. So, although scarce in reality, the concept is a prudent solution for many analysts and investors.
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