Introduction to Market Efficiency

Financial market prices are determined by market participants who process and respond to information by buying or selling securities. An __efficient market__ is one in which securities prices respond quickly and accurately to new information. Why do you think market efficiency is important to investors?

Incorrect. Efficient markets are not immune to wild price swings in response to market shocks. Shocks are a form of information that are processed very quickly.

Correct. Securities prices cannot be considered accurate if they are subject to change in response to information that is already known by market participants.

If securities markets are efficient, investors will not earn excess returns from strategies that are based on misinformed prices that will change after the information has entered the market. How do you think awareness of whether markets are efficient benefits investors?

Incorrect. Investors will accept normal returns available in efficient markets. In fact, awareness of whether markets are efficient benefits investors by allowing them to know whether to pay fees to investment managers who trade strategically. Fees are wasted in efficient markets as trading strategies cease to become effective over time. So in general, awareness of market efficiency helps investors determine whether to incur costs researching and developing strategies to achieve excess returns available from misinformed prices.

Correct. Fees are wasted in efficient markets as trading strategies cease to become effective over time. In fact, awareness of market efficiency helps investors determine whether to incur costs researching and developing strategies to achieve excess returns available from misinformed prices.

In summary: [[summary]]

Market efficiency is necessary to prevent wild price swings due to market shocks

Market efficiency ensures accurate prices for financial assets

Investors would avoid efficient markets and only deal in markets where excess returns are possible

Investors would know whether to pay fees to investment managers who trade strategically

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