Semi-strong Form Efficiency - Explained
What is Semi-strong Form Efficiency?
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Table of ContentsWhat is Semi-Strong Form Efficiency?How Does Semi-Strong Form Efficiency Work?Detailed Explanation of Efficient Market HypothesisImportant DetailsAn Illustration of Semi-Strong Form of Efficient Market Hypotheses
What is Semi-Strong Form Efficiency?
Semi-strong form efficiency is a concept that suggests that the release of public news of a particular stock increases its existing stock prices. This concept is a part of the Efficient Market Hypothesis (EMH).
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How Does Semi-Strong Form Efficiency Work?
Semi-strong form efficiency suggests that prices change to equilibrium levels, which are as a result of public market information on any security or equity. This theory analyses how the price of stocks increase and decrease with the presence of publicly available information. The semi-strong form efficiency theory, however, has one weakness; it is unable to explain the conditions affecting security prices on material nonpublic information (MNPI). The semi-strong form efficiency is easily the most applicable of all EMH hypotheses, as it deters the belief that technical and fundamental analysis can be used to achieve excess gains by investors. This concept goes on to suggest the use of MNPI as the only channel that could land investors big bucks and profits if they're in search of portfolios that yield more than average. The EMH theory is based solely on a 1960s Ph.D. dissertation by American Economist Eugene Fama, and it states that the prices of securities (stocks and other financial markets) at any given period in a cash market is dependent on the amount of information publicly available on that security. The EMH seems to draw most of its points from already existing researches, thus granting it some credibility up till date. This theory draws on the logic of the Random Walk theory (a theory that states that price changes are random and do not depend on any factor) to suggest that the ability to outperform a market security whose price is a reflection of its available market information is merely a matter of chance and not developed skills. In simple terms, one can compare trying to beat a market with public information to gambling. When applied to stock prices, it suggests that the market information of yesterday would in no way affect the price of stocks today, as there is new information today that takes up that role. It further states that beginners and advanced investors would be able to compete in the market if price changes were not predictable and if market information does not affect security rates. The EMH takes on three forms; the weak form efficiency, the semi-strong form efficiency, and the strong form efficiency.
Detailed Explanation of Efficient Market Hypothesis
As we stated earlier, the EMH has three forms on which it bases all its theory. The weak form EMH states that the movement of stock prices is solely dependent on the information available at that moment and non-other. In other words, the information of yesterday does not affect the security prices of today in any way. It also claims that technical analysis has no input in gathering excess returns, as history doesnt repeat itself in a random walk. The second form, which is the semi-strong form, has been defined above. The strong form of EMH, however, states that security prices are as a result of different information factors. It suggests that undisclosed private information has the same power in determining stock prices as publicly available information. It bases this argument on the fact that huge earnings in the financial market are not consistent because of the information which is not available to the public. If security prices were solely dependent on available information, then advanced investors will never record a loss. Just like all market price determinants, the EMH is not accurate at all times. This can be seen from the 2008 Financial Crisis, where investors questioned its credibility for lack of reality. They stated that if all forms of EMH had held as claimed, that the housing bubble and other crashes which came after it wouldnt have been possible. The EMH was unable to explain high volatility and market rationality. The later was observed in the way that investors were investing largely into the subprime mortgage sector even after reaching its peak (resistance point). This irrationality could not be explained by either form of EMH, even when investors where after high returns, which is a major goal of the efficiency theories. Different controversies raised around this model, as market analysts claimed that an efficient market would have modified asset prices to be on par with rational levels.
- The semi-strong form efficiency EMH hypotheses state that the price of a stock is dependent on its publicly available material information.
- It discredits the use of technical and fundamental analysis in predicting stock prices, arguing that the only true reflection of stock prices is dependent on material nonpublic information (MNPI).
An Illustration of Semi-Strong Form of Efficient Market Hypotheses
Let us assume that stock CSX is trading at $30 per unit, a day before it is required to release its annual financial report. Now, a rumor, at the later hours of the day, came in stating that the company has managed to have a great year with high financial returns. This rumor made the price of CSX increase to $40 per unit. However, the next day, after the financial report is made available, it is seen that the company has indeed suffered a financial decline, and this pushes the price back to $25. Now, the rumor which made the price jump to $40 is the publicly-available information, while the actual news which made the price fall back to $25 is the material nonpublic information (MNPI). If investors were to have an idea of the MNPI before its release, they would have profited a lot than they would. Also, investors that bought more stock shares at above $30 due to the rumor will suffer a loss after the MNPI is released publicly.