The concept of Market Efficiency:
Investors determine stock price on the basis of the expected cash flows to be received from a stock and the risk involved.
Rational investors should use all information they have available or can reasonably obtain. This information sets consist of both known information and beliefs about the future (i.e., information that can be reasonably be inferred).
Regardless of its form, information is the key to determination of stock price and therefore is the central issue of the efficient markets concept.
Market Efficiency is define an one in which the prices of all securities quickly and fully reflected all available information about the asset.
This concept postulates that all investors will assimilate all relevant information into price in making their buy and sell decisions.
Therefore, the current price of a stock reflects:
FORMS OF MARKET EFFICIENCY
In a perfectly efficient market, security prices always reflect immediately all available information, and investors are not able to use available information to earn abnormal returns, because it is already impounded in prices. In such a market every security’s price is equal to its intrinsic (investment) value, which reflects all information about that security’s prospects.
If some type information are not fully reflected in price or lags exist in the impoundment of information into prices, the market is less than perfectly efficient.
In fact, the market is not perfectly efficient, and it is certainly not perfectly inefficient, so it is a question of degree.
Exactly how efficient is the market?
Efficient Market Hypothesis (EMH):
Market efficiency concerned with the extent to which security prices quickly and fully reflect available information.
Efficient market hypothesis is divided into three categories-
One of the most traditional types of information used to assessing security values is market data, which refers to all past price (and volume) information. In a weak form efficient market, security’s current prices are already reflected of the historical price and volume data and should be of no value in predicting future price changes.