Provide a brief review of the evidence concerning the information efficiency of the world's major stock markets
Efficiency can be described as “the ability to achieve desired result without wasted efforts or energy” (Encarta dictionary, 2009).
In relation to financial markets, the measure of information efficiency can be assessed as being the speed with which security prices quickly and fully reflect all available information. Thus when information arises the news spreads very quickly and the effect is incorporated into the price of securities without delay. Investors are concerned with current or historic information since this influences commodity prices and so it follows that as more ...view middle of the document...
By contrast, Investopedia explains inefficient markets being evidenced where some securities are overpriced and others underpriced, which means investors can made abnormal returns/losses relative to their level of risk. Some investors have turned the gyrations of the financial markets into fortunes for instance Warren Buffet and John M Keynes whilst many other investors end up like Isaac Newton who after losing a bundle of stock exclaimed “I can calculate the motions of the heavenly bodies, but not the madness of people” (Larry MacDonald, 1998)
Evidence would suggest that markets cannot be entirely efficient or inefficient but a mixture seen as a mixture of both since if all participants in the market believed it to be efficient no investor would seek to make abnormal profits.
Secondly, provide a critical assessment as to whether or not the recent volatility in share prices and similar periods of extreme volatility (e.g. during the "dot com bubble") provide evidence of the inefficiency of stock markets in valuing the companies quoted in their exchanges.
The efficient market hypothesis is associated with random walk theory whereby share prices and all subsequent changes represent random departure from previous prices. Thus if information flows unimpeded and is immediately reflected in stock prices then tomorrow’s price will reflect only tomorrow’s news. However news in unpredictable and thus the resulting price changes are unpredictable and random, altering as new information becomes available. Essentially investors have access to all relevant information about a company and will therefore act upon the information in a rational manner.
There are number of influences that trigger price volatility often leading to the markets making egregious mistakes in valuing company shares. Markets are influenced by investor...