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‘The Efficiency Of A Stock Market Is Essential In Order For A Stock Market To Be An Efficient Allocator Of Resources.’ Discuss

1396 words - 6 pages

Stock markets are known as equity markets and market for trading equities. Stock exchanges are markets where government and Industry can raise long term capital and investors can buy and sell securities. Stock exchanges grew in response to the demand for funds to finance investment (especially in the early days) ventures in overseas trade. The world has changed dramatically over past years and new markets have emerged to compete with new existing markets. The following bar chart below, details the relative size of emerging stock markets around the world according to the total number of shares (markets capitalisation). Stock Market has two markets where primary market, companies issues new equity and secondary market where all the trading takes place.

An efficient stock market is described in the as ‘one in which information is processed quickly and accurately and so share process faithfully reflect all relevant information’. In simpler terms, prices are shows the best estimated or the true worth of the shares I the market in a coherent manner. In the simplest way, efficient stock markets are important due to the fact that it channels people’s savings, and those from other nations. If the country has a well-run, efficient and good exchange, into production and productive services and, if it is efficient, the stock market channels this money into those areas that most required. Stock Market efficiency is an important aspect to every country that contributes vastly to a countries economy performance; hence it is essential to be efficient in every aspect possible. Over the past few decades the question that has risen is ‘whether the stock markets are really efficient’.
In 1970 Fama published three different grading levels defining which markets were efficient, and this theory argues that a price of an asset is reflected by all the information that has been published or available. These three grading levels are Weak from efficiency, Semi-strong efficiency and Strong form efficiency.
Weak from of efficiency, where the it reflects all the past market information such as trading volumes and share prices is mirrored in the current share prices in the market and shows now indication on future share prices. Hence, future price indications will not be depending on the historical price movements. In this form of efficiency detecting a pattern of price movements can be inadequate due to the fact share prices will follow a random path and as a result of this it will be impossible to make gains by simply studying and monitoring historical data in the market. The second form of efficiency is in Fama’s theory is Semi strong efficiency where ‘efficiency’ is taken few steps further and describes a scenario where the current share prices are a true reflection of the past share prices and the all publically available information. In this form of efficiency investors, managers and other stakeholders have access to other information such as economic forecasts, price...

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