Stock Market Efficiency: Meaning and Practical Implications - Assignment Example

Download file to see previous pages The paper "Stock Market Efficiency: Meaning and Practical Implications" is a great example of a Finance & Accounting research paper. The stock market facilitates the allocation of funds for investment in the economy and also helps in decision-making at the firm level through the placement of equity for prospective shareholders at the stock market. The stock market is said to be efficient when the prices of securities fully reflect all the available information concerning the financial market. 

It would be unreasonable to assume that every participant in the stock is privy to the relevant information and able to act accordingly to such information. Nevertheless, Stiglitz (1993) observes that economists have shown that perfect information is not a necessity for efficiency in a market. Also, not every participant is required to act upon the information rationally. (Mishkin, 2007)

A stock market requires just a few people to have knowledge of prevailing circumstances and act rationally upon the information. This will affect the prices of the securities as though everybody had the information. “All it takes is a few people know enough to recognize a bargain, and prices will quickly be bid up or down to levels that reflect complete information.  And if prices reflect complete information, even uninformed buyers, purchasing at current prices, will leap the benefits.” (Stiglitz, page 267).

The implication of the fact that prices reflect all the information required in the market is that no individual regardless of the amount of information they have can outperform the market. If an investor outperforms the market, it is considered sheer luck.  If he/she intends to make money in an efficient market, selecting companies with prospective success is not sufficient. This is so because if other participants have the same information concerning the company, the price of the company’s shares will have risen.

Another consequence is that stock prices can only fluctuate positively or negatively when there is unanticipated new information about the stock to the investors. However, because the advent of new information is unpredictable, it is not possible to forecast the nature of the stock price change (whether up or down).  ...Download file to see next pages Read More