Option Trading Blog

This is a continuation of the posts about the Efficient Market hypothesis. In the last post about the EMH, I talked about what is known as Weak Form Efficiency. The next category is known as the semi-strong efficiency. The semi strong efficiency basically assumes that the prices reflect all public information. Here are a few examples:

• Financial reports
• Price information
• Possible upcoming mergers
• The competition the company has

In a semi strong market, as long as information about the company has not been made public, it does not affect its price.

Is it possible to predict future market moves from public information?

For the next paragraph, I’ll use the term abnormal returns. This means that the return of the stock minus the expected return by the CAPM model is positive. If you don’t know what is the CAPM model, don’t worry, I’ll post about it in the future.

According to the semi strong efficiency, no. There are several interesting research papers who studied the impact of public information on the price of the market. For instance, is it possible to make money by analysts recommendations? several researchers have tried to reach a conclusion and there wasn’t any clear conclusions. Some research indicated that stocks that received a Buy/Strong Buy recommendation, achieved abnormal returns and vice versa. The question is that needs to be answered though, what came first? Is it the analysts recommendations that made the stock rise in price ?

It is also interesting to consider the effect of stock repurchase/buy back (This means that the company that issued the stocks buys some of the stocks back). Recent research has shown that there is abnormal returns for stocks that have been repurchased. What does it mean? It appears intuitive to assume that the market participants assume that the company has more information and hence, if the company buys back it’s share, it means they are doing good.

To conclude, there are many more research papers that examined the effect of a phenomenon on the market and in most cases, the market appears to be efficient.