Market Efficiency in Brief

Market Efficiency in Brief

Rayenda Brahmana


My MSc dissertation is about Market Efficiency. It discussed the level of weak form market efficiency in South East Asia (Singapore, Malaysia, Indonesia, and Thailand). The purpose is to examine which stock market has better form in term of weak level of efficiency. I conducted R/S analysis, ACF, Probability Distribution, and GARCH (1,1) as the statistical tools to investigate the weak form efficiency. Market Efficiency is an old topic but still discussed ‘til today.


Ironically, some lecturers (not in USM or UoB) argue this topic should not be discussed further. They also argue market efficiency is not an interesting topic to discuss. They prohibit their supervisee researching about market efficiency which is a very idiotic way in learning process. If they prohibit investigating further about market efficiency, why don’t they stop discussing about capitalism or accounting?


Several students ask me about market efficiency and I just knew their lecturer do not teach them about market efficiency and just skip that section because the lecturers think market efficiency is out-of-date topic.


The latter, I will not debate about the importance of market efficiency issue in finance. I prefer to give a brief of market efficiency for those students. Hopefully, my short explanation can inspire them to dig further about market efficiency.


In 1900, Bachelier surprised finance world with his Ph.D thesis. He found Brownian motion in share prices, implying that share prices move randomly and does not follow systematic pattern. Then, in 1933, Cowels did the same research and found the same result that supported Bachlier’s work.


After the Brownian motion in stock trading found in the early 19th century, finance as a science converges to investigate the caused. Several scholars ended their conclusion that the caused of the Brownian motion in stock is market efficiency. This market efficiency usually measured by the speediness of stock reaction to newly information.


Further, Kendall and Hill (1953) attempted to study share prices behavior changes. Kendall found that knowledge of historical price changes yield none of information about future price changes and in speculative markets, history does not repeat itself.


Working (1934) and Alexander (1961) findings were consistent to Kendall works. Working (1934) argued that a series obtained by cumulating random numbers will for brevity and simplicity be called usually a random-differences series, since it is the first difference of the series an not the series itself, which are random number.


Alexander (1961) quoting the study of Kendall (1953) and Osborne (1959) stated that in an efficient speculative market, the price movements are random. Further, Guru of fractal analysis in finance, Benoit Mandelbrot, in 1966 presented the Martingale Model, implying that price series may not be random but its unbiased property does not allow the traders to exploit price dependences to secure super normal movements. Then, Smidt (1968), LeRoy (1989), and Roll (1994) observed the random walk hypothesis by using the Martingale Model and found it is remarkably hard to make profit even from the most extreme violations of stock market efficiency.


Cootner (1962) inferred that price movements in speculative markets are random and the returns tend to be significantly leptokurtic. Then Fama (1966) in his discussion paper stated that the returns are more skewed and the kurtosis. Stevensson and Bear (1970) also found the leptokurtic distribution of Soya Beans and Corns of CME.


Evans findings (1968), which conducted price movement study of 470 securities listed in S&P index of 1958-1967, state there is irrespective of the randomness or form characterizing the empirical distribution of security price changes. Further he found that although some degree of non-randomness exists in the distribution of security price changes, it is not of a magnitude that should be considered meaningful to investor dealing with portfolio of securities.


The peak of random walk booming was occurred when Fama in 1970 stated the efficient market hypothesis and classified the informational efficiency in three categories: weak form efficiency, semi-strong efficiency, and strong efficiency.


Eugene Fama in 1970, broke down the EMH into three forms, which are:

Weak Form Efficiency

The Information set considered includes only past information. The characteristics of this form are:

<!–[if !supportLists]–>a. <!–[endif]–>No excess returns can be earned by using the investment strategies based on historical share prices or other financial data

<!–[if !supportLists]–>b.<!–[endif]–>Technical Analysis will not be able to consistently produce excess returns

<!–[if !supportLists]–>c. <!–[endif]–>Fundamental analysis can be used to identify undervalue stocks and overvalue stocks.


Semi-strong Efficiency

The information set considered includes all publicly available information. The characteristics of this form are:

a. There will no excess return can be earned from publicly information

b. Fundamental Analysis techniques will not be able to reliably produce excess returns

c. All investor has the same interpretation of publicly information.


Strong Efficiency

The information set includes all information, whether publicly available or not. The characteristics are:

  1. Share prices reflect all information and no one can earn excess returns
  2. Strong efficiency market will be impossible if there are legal barriers to private information becoming public
  3. Investors can not consistently earn excess returns over a long period.


This market efficiency topic has very long debates until today. Many researchers debate the market efficiency theory and give the contrary results which are:

  1. Post Earning Announcement (Ball and Brown, 1968)
  2. Market Microstructure (Bagerhot, 1971)
  3. Growth Vs Value (Basu, 1977)
  4. Excessive Volatility and Volume (Shiller, 1981)
  5. Small Firm Effect (Banz, 1981)
  6. Long Term Price Reversal (DeBondt and Thaler, 1985)
  7. Equity Risk Premium ( Mehra and Prescott, 1985)
  8. Market Puzzle (Ritter,1991)
  9. Momentum Anomalies (Jegadeesh and Titman, 1993)
  10. Accrual Economy (Sloan,1996)
  11. Home Bias Puzzle (Hubermann, 2001)


In modern theory, an efficient market is not only created by the adjustment acceleration to the new information but also how the market fully reflected of all available information (Fama, 1991). A more rigorous definition is a market is said to be efficient with respect to particular information set, if it is not possible to generate excess return on the basis of trading on the information.


Thus, market efficiency topic is still an interesting topic to discuss. The psychology effect (behavioral finance) in traders’ decision making is also market efficiency topic (Kahneman and Tversk, 1979; Lo and Repin, 2001; Barbaris, Huang, and Thaler, 2006).


As the conclusion, even though market efficiency has started in the beginning of 20th century, it is an interesting to investigate it further; mainly, in this current financial crisis. Happy researching!

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Rayenda Brahmana

About research: google scholar: Others: twitter: @raye_brahm instagram: kolom.riset email: kolom.riset(at) raye_brahm(at)

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