Why should capital markets be efficient? Competition is the source of efficiency, and price changes should be independent and random.
In an efficient market, the expected returns implicit in the current price of the security should reflect its risk. Investors buying the security should receive a return that is consistent with the perceived risk of the security.
In an efficient capital market the majority of portfolio managers cannot beat a buy-and-hold policy on a risk-adjusted basis. An index fund which simply attempts to match the market at the lowest cost is preferable to an actively managed portfolio.
Market Value versus Intrinsic Value
In an efficient market, the two values should be very close or the same. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value. Though market value and the intrinsic value may differ across time, the discrepancy will get corrected as new information arrives.
In an inefficient market, the two may differ significantly.
Factors Affecting a Market's Efficiency
Some factors contribute to and impede the degree of efficiency in a financial marke
Transaction costs and information-acquisition costs should also be considered when evaluating market efficiency.
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