Introduction
Investors can access critical capital market information at the click of a button, unlike in the past where it would take a longer time before information reaches the investors. Therefore, informational efficiency of stock prices in the capital market allows investors to make the most appropriate investment decisions.
Behavioral Challenges in Achieving Efficiency
There are several behavioral challenges to achieving capital market efficiency. The challenges relate to rationality, independent deviations from rationality, and arbitrage ( Tuyon & Ahmad, 2016) . With regards to rationality, it is important to realize that people are not always rational. They may not be objective in analyzing capital market information in order to make the most appropriate investment decisions. For instance, most investors fail to diversify by trading too much. In fact, some may even try to maximize taxes by selling winners and holding losers. Some other behavioral challenges include independent deviations from rationality where people tend to deviate from rationality in predictive ways. For instance, some investors based their decisions on too little data, leading to bubbles in security prices. The last behavioral challenges relates to arbitrage where some investors may consider shorting prices in a bid to make other investors come to their senses. Such investors sell high and buy low. However, arbitrage can be risky especially if the rest of the investment community does not come to their senses.
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Forms of Market Efficiency
There are three common forms of market efficiency; the weak from, semi-strong form, and strong form ( Kristoufek & Vosvrd a, 2014) . The weak form of market efficiency is generally based on the belief that current stock prices reflect all the data of past prices and that no form of technical analysis can be effectively utilized to assist investors in making informed decisions. In this form of market efficiency, investors are believed to research companies’ financial statements to make decisions. In the semi-strong form of market efficiency, it is believed that neither technical nor fundamental analysis cannot be utilized by investors to gain higher returns in the market because all public information is used to calculate a stock’s current price. As such, those that subscribe to this form of market efficiency are of the opinion that only the information that is not available to the public can help investors increase their returns. In the strong form of market efficiency, it is believed that all information is completely accounted for in the current stock prices and that no type of information can give an investor an advantage on the market. Based on the strong form of market efficiency, investors cannot gain returns that exceed normal market returns.
Implications to Corporate Finance
Capital market efficiency has three implications to corporate finance. Firstly, the price of a firms stock cannot be affected by changes in accounting. Thus, accounting records cannot be used to influence stock prices. Secondly, financial manages cannot time issues of bonds and stocks based on publicly available information ( Cho, 2015) . Financial managers need to be analytical in the way they approach issues stock and bonds. Thirdly, capital market efficiency theory suggests that a company can sell as many shares of stocks or bonds as possible without necessarily depressing prices. Therefore, companies do not have to limit their stock or bond sales in order to avoid depressing prices.
The Real Estate Market
Basically, the real estate market is not an efficient capital market. This is because the market prices do not correctly reflect all pertinent information. Oftentimes, all relevant information is not available in real estate. For instance, there can be multiple correct prices for a piece of property, based on what the buyer intends to do with the property. Furthermore, the sellers are not always motivated solely by the price.
Conclusion
In conclusion, the efficiency of capital markets can be increased by making it easy to obtain and process all pertinent information relating to a given stock. This is because current prices tend to reflect all the relevant information relating to the stock. As such, the existence of undervalued or overvalued stocks presents profit opportunities to the investors. Thus, the study of capital market efficiency helps investors and corporate to examine how fast and accurate available information is accounted for in security prices.
References
Cho, Y. J. (2015). Segment disclosure transparency and internal capital market efficiency: Evidence from SFAS No. 131. Journal of Accounting Research , 53 (4), 669-723.
Kristoufek, L., & Vosvrda, M. (2014). Commodity futures and market efficiency. Energy Economics , 42 , 50-57.
Tuyon, J., & Ahmad, Z. (2016). Behavioural finance perspectives on Malaysian stock market efficiency. Borsa Istanbul Review , 16 (1), 43-61.
