• Predicting future asset prices is not always accurate (represents weak efficiency form)
• Asset prices always reflect all new available information quickly (represents semi-strong efficiency form)
• Investors can't outperform on the market often (represents strong efficiency form)
Sunday, October 3, 2010
Information arbitrage efficiency
Asset prices fully reflect all of the privately available information (the least demanding requirement for efficient market, since arbitrage includes realizable, risk free transactions)
Arbitrage involves taking advantage of price similarities of financial instruments between 2 or more markets by trading to generate losses.
It involves only risk-free transactions and the information used for trading is obtained at no cost. Therefore, the profit opportunities are not fully exploited, and it can be said that arbitrage is a result of market inefficiency.
This reflects the weak-information efficiency model.
Arbitrage involves taking advantage of price similarities of financial instruments between 2 or more markets by trading to generate losses.
It involves only risk-free transactions and the information used for trading is obtained at no cost. Therefore, the profit opportunities are not fully exploited, and it can be said that arbitrage is a result of market inefficiency.
This reflects the weak-information efficiency model.
Fundamental valuation efficiency
Asset prices reflect the expected past flows of payments associated with holding the assets (profit forecasts are correct, they attract investors)
Fundamental valuation involves lower risks and less profit opportunities. It refers to the accuracy of the predicted return on the investment.
Financial markets are characterized by predictability and inconsistent misalignments that force the prices to always deviate from their fundamental valuations.
This reflects the semi-strong information efficiency model.
Fundamental valuation involves lower risks and less profit opportunities. It refers to the accuracy of the predicted return on the investment.
Financial markets are characterized by predictability and inconsistent misalignments that force the prices to always deviate from their fundamental valuations.
This reflects the semi-strong information efficiency model.
Full insurance efficiency
It ensures the continuous delivery of goods and services in all contingencies.
Functional/Operational efficiency
The products and services available at the financial markets are provided for the least cost and are directly useful to the participants.
Every financial market will contain a unique mixture of the identified efficiency types.
Every financial market will contain a unique mixture of the identified efficiency types.
Conclusion
Financial market efficiency is an important topic in the world of Finance. While most financiers believe the markets are neither 100% efficient, nor 100% inefficient, many disagree where on the efficiency line the world's markets fall.
It can be concluded that in reality a financial market can’t be considered to be extremely efficient, or completely inefficient.
The financial markets are a mixture of both, sometimes the market will provide fair returns on the investment for everyone, while at other times certain investors will generate above average returns on their investment.
The Dumb Agent Theory states that many people making individual buying and selling decisions will better reflect true value than any one individual can. In finance this theory is predicated on the efficient-market hypothesis (EMH). One of the first instances of the Dumb Agent Theory in action was with the Policy Analysis Market (PAM); a futures exchange developed by DARPA While this project was quickly abandoned by the Pentagon, its idea is now implemented in futures exchanges and prediction markets such as Intrade, News futures and Predictify.
While first mentioned strictly by name in relation to PAM in 2003, the Dumb Agent Theory was originally conceived (as the Dumb Smart Market) by James Surowiecki in 1999 Here, Surowiecki differentiated from the EMH stating that it "doesn't mean that markets are always right." Instead, he argues that markets are subject to manias and panics because "people are always shouting out" their stock picks.
This, in turn, results in other investors worrying about these picks and become influenced by them, which ultimately drives the markets (irrationally) up or down. His argument states that if market decisions were made independently of each other, and with the sole goal of being correct (as opposed to being in line with what others are choosing), then the markets would produce the best choice possible and eliminate biases such as Groupthink, the Bandwagon effect and the Abilene Paradox.
It can be concluded that in reality a financial market can’t be considered to be extremely efficient, or completely inefficient.
The financial markets are a mixture of both, sometimes the market will provide fair returns on the investment for everyone, while at other times certain investors will generate above average returns on their investment.
The Dumb Agent Theory states that many people making individual buying and selling decisions will better reflect true value than any one individual can. In finance this theory is predicated on the efficient-market hypothesis (EMH). One of the first instances of the Dumb Agent Theory in action was with the Policy Analysis Market (PAM); a futures exchange developed by DARPA While this project was quickly abandoned by the Pentagon, its idea is now implemented in futures exchanges and prediction markets such as Intrade, News futures and Predictify.
While first mentioned strictly by name in relation to PAM in 2003, the Dumb Agent Theory was originally conceived (as the Dumb Smart Market) by James Surowiecki in 1999 Here, Surowiecki differentiated from the EMH stating that it "doesn't mean that markets are always right." Instead, he argues that markets are subject to manias and panics because "people are always shouting out" their stock picks.
This, in turn, results in other investors worrying about these picks and become influenced by them, which ultimately drives the markets (irrationally) up or down. His argument states that if market decisions were made independently of each other, and with the sole goal of being correct (as opposed to being in line with what others are choosing), then the markets would produce the best choice possible and eliminate biases such as Groupthink, the Bandwagon effect and the Abilene Paradox.
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