Financial Markets

Introduction

Market efficiency is the level in which prices are aligned to all available, sufficient and relevant information. The concept was developed by an economist by the name Eugene Fama. Fama noted in the theory of Efficient Market Hypothesis that, it Is impossible for an investor to outdo the market because all information that is available is constructed in stock prices. Market efficiency weighs the availability of market data which provides huge amount of opportunities to buyers and sellers to conveniently transact without adding unnecessary transaction cost. On other hand, behavioral finance is a field that seeks to blend behavioral and cognitive theory of psychology with economic and finance to provide explanation to why people make illogical decisions. There are many instances where people’s psychology affects their decisions making them to make irrational decision. Behavior finance is a new method that came to existence to respond to problems faced by early investors. The concept of behavior finance argues that some financial situations can be clearly understood using principle that are fairly rational.

Market Efficiency

Market efficiency is a theory of financial economist that argues that prices of various assets reflects the information that is available. The approach explains that stock trade a reasonable prices compelling investors either to buy stock that is underrated, or dispose stock with inflated prices. This implies that, is impossible for investors to outshine the whole market and the only way to realize high return from investments is by chance of acquiring risky investments.

Classification of market efficiency

Weak efficiency

In this classification of market efficiency, futures stock prices cannot be determined by looking at past trends. Returns in the long run cannot be made by just looking at historical data. Performing technical analysis will show no consistency in production of excess return, but rudimentary analysis may exhibit excess return. Stock prices will show no interrelation, implying that there is no pattern that exist that can be used to set prices. With this in mind, expected prices are determined by data not available in the price series and prices must assume an unplanned walk. In this category of market efficiency, it is not mandatory for prices remain at equilibrium, but only the investors who have responsibility of generate profit out of market inefficiencies.

Semi-strong Market efficiency

This class of efficient market Hypothesis suggest that all available information is manipulated into stocks current share price, implying that neither fundamental nor technical analysis can be used to realize high profit. Semi-strong Market efficiency allow use of information that is publicly available, which can be used by investors who are seeking to make abnormal profits.

Strong Market efficiency

This type of market efficiency advocates that all information; publicly available or not publicly known, can be used to account for current change in prices. The approach does not give an investor any advantage over the market and advocates that an investor cannot make profit that is above market returns, irrespective of data or data retrieved or researched.

Efficiency and market assumptions

Efficiency in markets suggests that financial markets uses all known data sources. How long a market hypothesis can last is debatable? But in regard to this, whether or not market efficiency is useful in financial marketing concepts which show the behavior of financial markets situations. Efficiency markets puts into consideration, that important information is a reflection to real market situation and assumes that financial figure are always set correctly. There is assumption that stock is never underrated or overvalued. It implies that investors in the stock markets cannot outperform the entire market by adopting extensive growth strategies.

Implications of Market Efficiency

The market efficiency has been a reliable hard evidence though it is not correct to say it is conclusive of all the events that happens. Market efficiency is based on high degree of acceptance amongst the interested group which plays an important role on supporting practical conclusion on market. Instead of selecting stock, it makes more sense to acquire funds using passively manageable approaches which are characterized with low commissions and be in a position to derive a full marketing returns. When picking potential employees or shares, it is considered a good approach not to have people who have high hiring and remuneration cost because the anticipated profit margin is not that too high. When people are trying to beat a high performing company, it is good to attempt and beat the market by having rational ideas about market efficiency. In respect to this approach, it is advisable not to try to outperform the market by having intelligent markets but having better fund managers who put more effort in identifying market efficiency. Some practitioners argue that it is justifiable to have bad securities which are characterized by market inefficiency. Individual should not feel isolated or have a bad feeling about their portfolio analysis but instead, they should develop a better way of judging their analysis.