Semi-strong Form Market Efficiency

Semi-strong form of market efficiency exists where security prices already reflect all publicly available information and it is not possible to earn excess return.

Semi-strong form of market efficiency lies between the two other forms of market efficiency, namely the weak form and strong form. A semi-strong form encompasses a weak-form which means that if a market is semi-strong efficient, it is also weak-form efficient.

When a market is semi-strong form efficient, neither technical analysis, which is based on past pattern of return, nor fundamental analysis, which incorporates current information, can help predict future price movements. However, non-public information can be used to earn above average return.

Semi-strong form of efficiency is typically tested by studying how prices and volumes respond to specific events. If price reflect new information quickly, markets are semi-strong form efficient. Such events may include special dividends, stock splits, lawsuits, mergers and acquisitions, tax changes, etc. Evidence suggests that developed markets might be semi-strong efficient while developing markets are not.

Example

Alex held 100 shares of Cure Inc. which he had purchased on 1 January 20X3 for $25 per share. Cure Inc. is a company engaged in research and development of new antibiotics against resistant microbes. Alex is not an active investor so he does not checks the stock performance daily. On 14 January 20X2 (Sunday), he came across an article shared by his friend on Facebook. The article was published on 11 January 20X2 (Friday). According to the article, Cure Inc. has failed in a project worth a net present value of $20 million. Total outstanding shares of Cure Inc. are 5 million. Alex sold off his holding for $2,050 (at $20.5 per share) in the opening hours of 15 January 20X2 (Monday). He was glad that he minimized his loss but towards the end of 15 January 20X2, the company's stock price had even climbed to $21. He is wondering what happened.

The market seems to be semi-strong form efficient. The market had adjusted itself to the public information on Friday (11 January 20X2) as soon as the market came to know about it. Alex should not have used this public information to project a decline on Monday. The drop in price is almost equal to the net present value per share no longer available ($20 million divided by 5 million).

by Obaidullah Jan, ACA, CFA and last modified on

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