The Semi Strong Form of the Efficient Market Hypothesis Essay

Published: 2020-02-15 15:30:04
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Category: Financial markets

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One of the major theories that form the basis of financial market is the efficient market hypothesis. The extreme position of those who advocate the efficient market hypothesis claims that all the market requires is basic financial information. The semi-strong form of the efficient market hypothesis states that the market incorporates all the known information about a stock, the current price reflects this information, and this information is incorporated in the price very rapidly.

Thus, an investor cannot use the known public information to make a more-than-normal return. Let us assume that two otherwise identical firms are presenting income statements, but that one firm uses the straight-line method in depreciating its equipment while the other firm uses the double declining balance method. The differences in accounting are fully explained with supporting schedules in their respective reports. The efficient market hypothesis, given the assumptions, suggests that both common stocks would sell for exactly the same price.

The market would adjust for the accounting practices, so only the real differences would remain. In this case, there are no real differences; thus, the stock prices of the two firms would be identical. A person who believes in the semi-strong form of the efficient market would argue that more attention should be directed toward obtaining completeness of disclosure and improving the timing of the announcements containing information rather than toward the form of the presentation.

A person who doubted that the market was perfectly efficient in the semi-strong form might agree with the importance of completeness of information disclosure and the importance of timing, but he or she would still argue that the form of presentation made a difference to enough investors so that the accounting problems were still a relevant area and the improvement of accounting practices was a valid endeavor.

In addition, since the processing of information has a cost, the accountant has an obligation to refine the information and present it in as good form as is feasible so that information processing costs can be reduced. While one might not agree completely with the semi-strong form of the efficient market hypothesis, it would be incorrect to argue that the market is perfectly fooled by differences in accounting practices and makes no adjustment for such differences.

If one firm is using FIFO (first-in, first-out) and a second firm is using LIFO (last-in, first-out), the market is likely to be making some type of adjustment for the fact that two different accounting assumptions are being used. We would expect the market to make reasonably good adjustments where the supplemental information is clearly presented, but in some cases, where the information is not clear or is not publicly available, the adjustments may not be as effective. This brings us to the strong form of the efficient market hypothesis.

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