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Market hypotheses

Efficient market hypotheses:

a) Weak-form efficient market hypothesis: It assumes that current stock prices reflect all security market information including the historical sequence of prices, rates of return, trading volume data and other market generated information. This hypothesis implies that past rates  of return and other historical market data have no relationship with the future rates of return. For investment purpose, this means that one would not be able to gain by using any trading rule that decides whether to buy or sell a security based on past rates of return or any other security market data.

b) Semistrong-form efficient market hypothesis: It asserts that security prices rapidly adjust to the release of all information i.e. current security prices reflect all public information. This hypothesis encompasses the weak form hypothesis because all the market information considered by the weak form hypothesis such as stock prices, rates of return and trading volume is public. Public information also includes all non-market information like earnings and dividend announcements, price to earnings ratio, stock splits, economic and political news. From the investment point of view, the investors who base their decisions on any important new information after it is public should not derive above average risk adjusted profits from their transactions.

c) Strong-form efficient market hypothesis: This contends that stock prices fully reflect all information from public and private sources. This means that no group of investors has monopolistic access to information relevant to the formation of prices. From investment point of view, no group of investors should be able to consistently derive above average risk adjusted rates of return.

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