Efficient capital market

Market efficiency as applied to securities markets means that it is on average impossible to gain from trading on the basis of generally available public information (information-arbitrage efficiency) and that the valuation of an asset reflects accurately the future payments to which the asset gives title (fundamental-valuation efficiency). It is apparent that market efficiency in this sense is only part of overall market efficiency.

Fama (1970) distinguishes three forms of informational efficiency: He defines weak, semi-strong and strong form efficiency as holding when the stock market prices reflect all historical price information, all publicly available information, and all information (including insider information), respectively. In order for the price to reflect exactly all information about an asset, nothing can impede the purchase or sale of securities, such as brokerage, fees, taxes and so on. To the extent that impediments exist to the trading of an asset, the prices will only imperfectly reflect information of relevance to the valuation of the security.

Most financial markets have generally been shown to be efficient in the weak or semi-strong form, although not necessarily so in the strong sense.

See also: efficiency

Literature: Blume & Siegel (1992), Fama (1970)

Entry by: Eva Kramer

November 17, 1997 Direct questions and comments to: Glossary master