Market efficiency ensures prices reflect all available information from "summary" of Financial Markets and Institutions, Global Edition by Frederic S. Mishkin,Stanley G. Eakins
Market efficiency is a key concept in financial markets that has significant implications for investors and the economy as a whole. It refers to the idea that prices in financial markets incorporate all available information, meaning that assets are always priced at their fair value. This concept is based on the Efficient Market Hypothesis, which suggests that it is impossible to consistently outperform the market because prices already reflect all available information. In an efficient market, investors cannot expect to earn abnormal returns by simply picking stocks or timing the market. This is because any information that could potentially lead to abnormal returns is quickly incorporated into asset prices, making it difficult for investors to gain an edge. As a result, market efficiency is seen as a fundamental principle that underpins the functioning of financial markets. There are three forms of market efficiency: weak, semi-strong, and strong. In weak form efficiency, prices reflect all historical information, meaning that past price movements cannot be used to predict future price movements. In semi-strong form efficiency, prices reflect all publicly available information, including news and announcements. Finally, in strong form efficiency, prices reflect all information, both public and private, making it impossible for anyone to consistently beat the market.- As it suggests that trying to outperform the market through stock picking or market timing is likely to be futile. Instead, investors are better off focusing on diversification and low-cost index funds, which offer a more reliable way to earn market returns. Overall, market efficiency ensures that prices in financial markets are a reflection of all available information, making it difficult for investors to gain an edge through superior knowledge or analysis.
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