MODULE 3: MARKET EFFICIENCY

Market Efficiency

1. In an efficient market, prices already reflect all available information, so they're fair estimates of value; the return you earn is just pay for risk, not for being clever — in short, you can't consistently beat the market.
2. When markets are efficient, passive investing makes sense because active trading gets eaten up by fees and costs; only when prices are genuinely wrong does active investing have a chance to add value.
3. Prices move only on surprises, not on expected news: earnings up 45% is good, bad, or irrelevant depending entirely on what the market had already priced in.
4. Market value is the asset's current price, while intrinsic (fundamental) value is what a fully informed, rational investor would be willing to pay; in highly efficient markets, the two usually line up, but in less efficient markets active investors try to buy below intrinsic value and sell above it.
5. Intrinsic value is based on fundamentals — for a bond, this means coupon, maturity, default risk, liquidity, and other key characteristics. Intrinsic value is constantly changing as new (unexpected) information becomes available.
6. Information + attention: markets are more efficient when lots of participants track them and when information is public, timely, and equally available. Fewer analysts, poor disclosure, or selective leaks ⟶ slower price adjustment and mispricing.
7. Ability to trade and correct prices: arbitrage and short selling pull prices back to fair value, but only if trading is easy. High transaction costs, low liquidity, funding limits, or short-sale constraints let wrong prices survive.
8. Costs decide real efficiency: markets are efficient if, after all information, trading, and funding costs, no positive risk-adjusted returns are left. Beating the market before fees doesn't count if you lose after fees.
9. When we talk about market efficiency ⟶ We talk about return adjusted for risk. For this you need a model for expected returns such as CAPM.
10. Weak Form Efficiency:
11. Costs decide real efficiency: markets are efficient if, after all information, trading, and funding costs, no positive risk-adjusted returns are left. Beating the market before fees doesn’t count if you lose after fees.
12. When we talk about market efficiency → We talk about return adjusted for risk. For this you need a model for expected returns such as CAPM.
13. Technical analysis seeks to earn positive risk-adjusted returns by using historical price and volume (trading) data. These guys just harvest risk premia.
14. Weak Form Efficiency:
    1. Market prices reflect all the information in the historical market data. An investor cannot achieve positive risk-adjusted returns on average by using technical analysis because past price and volume (market) information will have no predictive power.
    2. Trading on fundamentals or Trading on private information can still give you an edge.
15. Semi-Strong-Form Efficiency:
    1. Current security prices fully reflect all publicly available market and non information.
    2. Trading on private information can still give you an edge.
16. Strong-Form Efficiency:
    1. Security prices fully reflect all information from both public and private sources.
    2. You just can't beat the market.
17. Tests indicate that mutual fund performance has been inferior to that of a passive index strategy.
18. The majority of evidence is that anomalies are not violations of market efficiency but are due to the research methodologies used.
19. Event studies test semi-strong efficiency: they ask whether you can make abnormal profits after public news. In developed markets, prices adjust almost immediately, so the null holds. Example: Apple launches a new iPhone, the stock barely moves on launch day because it's already priced in. In less efficient markets, even well-known events (like Diwali sales numbers) can lead to slow, multi-day price reactions.
20. Market Anomalies break market efficiency. Momentum is an anomaly. Small cap outperforming Large cap is an anomaly (Size Effect). Low P/E ratio stocks outperform High P/E ones (Value Effect). Price action die to earning surprises persist for days, IPOs are typically underpriced, NAV of closed end MF is undervalued.
21. Information cascade: less-informed investors copy early, better-informed traders; if the early movers truly have superior information, this herding can actually help prices move closer to intrinsic value rather than distort them.