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Stock Market: Efficient Allocator Of Resources?

1735 words - 7 pages

In answering the question on discussion whether it is important for stock markets to be efficient in order to fulfil its roles, it is important to discuss the roles and the functions of the stock market and why it is important for the stock market to be efficient in order to be able to operate and to perform its role as an efficient allocator of resources.. Secondly it is essential to look at the concept of capital market efficiency and what it means. Clearly, market efficiency is a concept that is controversial and attracts strong views, partly because of the differences in the way individuals explains the concept, and partly because it is believed that it determines how an investor will approach an investment. Finally discuss the types of efficiency and whether it’s only important for the stock market to be allocative efficiency in order to operate or they are other types of efficiency which also help the stock market to fulfil its roles.
Stock markets are markets where government and industries can raise long term capital and where investors can buy and sell securities. Stock markets are established for the purpose of assisting, regulating and controlling business of buying, selling and dealing in securities. They provide a market for the trading of securities to individuals and organizations seeking to invest their saving or excess funds through the purchase of securities. Stock markets play a role in the supervision of trading to ensure fairness and efficiency. Stock markets perform an important role in making sure that there is fair pricing in the market. The mechanism of the stock market enables buyers and sellers of securities, to receive the best price possible for a particular stock. There are several roles and functions of the stock market. Fama indicates that ‘the primary role of the capital market is allocation of ownership of the economy’s capital stock’ (Farma 1970). His stated ideal market is one in which prices provide accurate signals for resource allocation: that is, a market in which firms can make production-investment decisions, and investors can choose among the securities that represent ownership of firm’s activities under the assumption that security prices at any time ‘fully reflect’ all available information. (Farma 1970).It’s important that society’s scarce resources are allocated efficiency, Stock markets help in this process.

In an efficient stock market security prices reflect all available information. The efficient market hypothesis (EMH) implies that if new information is revealed about the firm it will be incorporated in to the share price rapidly and rationally, with respect to the direction of the movement and the size of that movement. (Arnold. G. 2008. p 563). In an efficient stock market no trader will be able to consistently make abnormal profits as the prices follow a random walk. The efficient market hypothesis is concerned with establishing the prices capital market securities and states that...

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