Financial fundamentals consist of verifying that the prices observed in a market are always equal to the fundamental value and that they no longer fluctuate around that fundamental value.

The difference here is size. As a matter of fact, if prices fluctuate randomly around the fundamental value, it is possible to buy securities with prices lower than the fundamental value.

On the other hand, if prices are always equal to the fundamental value, it is quite clear that profits cannot be expected by speculating on the difference between the two.

It then proposes a new definition of activity. A market is efficient based on the information set if it is impossible to make economic profits by speculating on the basis of the information set.

Returns can be (weakly) dependent. But it is impossible to speculate on this dependence to create abnormal profits. In other words, the predictability of returns does not necessarily imply the possibility of realizing excessive profitability.

Classification

The definition that a market is information efficient if the price observed in the market fully and instantly reflects all available information takes into account the information context as a whole. Therefore, it proposes three modes of activity based on the information contained in this available set of information.

We distinguish it as follows:

– Efficiency in the weak sense: The current information set contains only the history of price and yield series. Weak form tests are basically random walk tests and aim to determine whether future returns can be predicted from past returns.

– Efficiency in a semi-strong sense: The information set contains all publicly available information. This information can include any information about efficiency in the weak sense: the current information set includes only the history of the price and yield series.

Weak form tests are basically random walk tests and aim to determine whether future returns can be predicted from past returns.

This information includes annual reports, earnings announcements, bonus share distributions, information in the press, etc. regarding the issuing company. It can contain any kind of information.

The aim is to test whether prices adapt quickly to this information, i.e., whether the market accurately predicts the release or publication of results.

– Efficiency in a strong sense: The information set includes any private information in addition to public information. The tests aim to determine whether individuals with monopolistic access to information can generate higher profits than other intermediaries.

Lack of Change

An efficient market is one where prices reflect all available information and agents have rational behavior and expectations. However, if the prices reflect all available information and the intermediaries act rationally, the market disappears.

As a matter of fact, under these conditions, there will be no barter as all intermediaries will want to sell securities that will decrease in price and buy securities that will increase in price. Without trade, the market cannot exist.

So here we see a contradiction that emerges within the very definition of activity.

If the market is efficient, the actors who make their decisions based on information have nothing to do with trying to obtain this or that kind of information. Therefore, if markets are information efficient, seeking and obtaining information is a waste of time.

So how is this dilemma resolved and specifically how is the market regulated?

The solution, then, consists in assuming that the intermediaries act as if the market were ineffective. A second possible interpretation consists in assuming that we are no longer trading at date t because we are in equilibrium.

So, in equilibrium there is no longer any speculative motivation to trade. Secondly, there will be information, trial and error and new updates. In this case, an efficient market does not lead to the absence of trade.

Asymmetries and Information Costs

Free information is the basis for prices to reflect all information. Of course, that doesn’t seem extremely realistic. The existence of information acquisition and processing costs has very strong implications for productivity as shown.

Second, it develops a model in which the two categories coexist. There are knowledgeable agents who obtain information at a cost, and uninformed agents who only observe prices.

If there is no noise in the market and agents become more and more informed, all information is communicated to unannounced agents via prices.

In an active market where prices reflect all available information, every knowledgeable agent stops paying for information and pays nothing. He thinks he can only act as well as an uninformed agent observing knowledge education through prices.

This leads to a lack of interest in investing in gaining knowledge. If all the informed agents do the same, they will try to extract the information from the price system which no longer contains any information.

Therefore, there is no competitive equilibrium to suggest that free knowledge is not only a sufficient condition for the validity of informational effectiveness, but also a necessary condition.

Dr.Yaşam Ayavefe