International Stock Exchanges & Stock Market Efficiency

Last week, the lecture is about an appreciation of the importance of a stock market in a sophisticated financial system is a necessary precursor to understand what is financial markets, stock market and the efficiency of markets. The relationship with them is the stock market is one breakdown of capital markets, which is one of the components of financial market.

Consider about the stock market, it is linked to the stock exchange, which are market where government and industry can raise long-term capital and investors can buy and sell securities (Arnold, 2008). Stock exchange grew because of the demand for funds to finance investment and ventures in overseas trade. While the question of whether the stock market is efficient in pricing shares and other securities has fascinated academics, investors and businessmen for a long time. Because an efficient market can encourage share buying. An accurate price is necessary for individuals who are willing to invest in private firms. They need to know the price they are paying is fair and they can sell at a fair price. Fair is important in the market. And efficient share market is able to give the right information to managers. As a company, one of the missions is to maximise the shareholder wealth. Managers need to be assured that the implication of the decision is accurately signalled to shareholders through rise the share price. Additionally, share price will represent the rate of return investors demand for a particular risk class. Another reason is allocating resources.

Due to the share price at any time reflects all available information and it will only change when new information comes out. Because when news arrives, it is unknown if it will be good or bad. Therefore, another theory related to the efficient market hypothesis created by Louis Bachelier is the “random walk” theory, which states that the prices in the financial markets evolve randomly and are not connected, they are independent of each other. Hence, identifying trends or patterns of price changes in a market couldn’t be used to predict the future value of financial instruments. The following chart shows the movement on the FT 100 share index.

Source from: www.londonstockexchange.com

Back to market efficiency, there are four efficiency types that could be present in a financial market: operation efficiency, allocational efficiency, and pricing efficiency. Every financial market will contain a unique mixture of the identified efficiency types.

Eugene Fama identified three levels of it, which are weak-form efficiency, semi-strong efficiency, and strong-form efficiency.

1.    Weak-form efficiency

Prices of the securities instantly and fully reflect all information about the past prices. This means future price movements cannot be predicted by using past prices. It is simply to say that, past data on stock prices are of no use in predicting future stock price changes. Everything is random. In this kind of market, should simply use a "buy-and-hold" strategy.

In 6^th Feb. The Shares in Twitter plummet after company reported a net loss of $645m (£396m) for 2013, just three months after its flotation on the New York Stock Exchange. The loss was expected by analysts, who highlighted Twitter's revenues, which rose 110% last year to reach $665m. Shares fell 24% to $50.03. see chart below. It shows that the prices of the securities instantly and fully reflect all information about the past in Twitter.Because shares in the company plunged in trading after the company announced its first financial results as a public company.

2. Semi-strong efficiency

Asset prices fully reflect all of the publicly available information. Therefore, only investors with additional inside information could have an advantage on the market. Any price anomalies are quickly found out and the stock market adjusts.

3. Strong-form efficiency

Asset prices fully reflect all of the public and inside information available. Therefore, no one can have advantage of the market in predicting prices since there is no data that would provide any additional value to the investors.

Financial market efficiency is an important topic in the world of Finance. While there is a common that in the markets, there is neither 100% efficient, nor 100% inefficient. Therefore, it can be concluded that in reality a financial market cannot 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. Investors should consider the pros and cons, and have clear knowledge of potential risk before making investment.