81. Market Efficiency Theory
Students of finance are familiar with models such as die Capital Asset
Pricing Model (CAPM) or arbitrage pricing theory (APT), which describe
the structure of stock prices based on different factors. In fact, practitioners
are much more interested in how fast stock prices fluctuate in response to
changes to the relevant factors. To examine these patterns of change, we
need to understand the concept of financial market efficiency.
A financial market is considered efficient if the current prices of
securities fully reflect all information about factors such as the health of the
national and international economies, and data about the performance of
the companies traded in the market. Changes to these factors result in
changes in the intrinsic value of securities. Price fluctuations, therefore,
depend upon how rapidly the market reacts to new information.
Eugene Fama, a pioneer in efficient markets research, has described
three forms of market efficiency: weak, semistrong, and strong. Take the
recent case of Bibica (VNSE: BBC). The company was losing money and
the price of its stock was falling. According to Fama's hypothesis, in the
weak form of efficiency, the current price of a stock fully reflects the
historical sequence of prices. Therefore, the price of Bibica stock would not
drop immediately when the financial losses were announced. According to
the second type of market efficiency, in which current prices reflect all
publicly available information, such as information from financial reports
and the media, the price of BBC stock would drop when the bad news was
publicly announced. In the strong form of market efficiency, current prices
fully reflect all information, both public and private. In such a market the
price of BBC stock would have fallen while the company was running at a
loss, regardless of whether information regarding the losses was publicly
available or not.
