Market Efficiency Theory
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For This paper they are three main questions to respond to, and its is critical that the writer detail explain why responding to the questions. The pliagiarism report should be almost zero. And APA 6th Edition must be used throughout the entire paper.
Market Efficiency Theory
After reviewing your resources below , consider the following. The theory of market efficiency is based on the premise that a market is considered efficient when stock prices are an actual reflection of information known about a company. U.S. markets are generally viewed as semi-strong form market efficient.
• What would happen if U.S. markets became less efficient?
• What might lead to markets becoming less efficient?
• How do markets in other countries compare to the U.S. in terms of efficiency?
Resources
• Article
• Markowitz, H. (2005). Market efficiency: A theoretical distinction and so what? Financial Analysts Journal, 61(5), 17–30. Retrieved from Business Source Premier database.
In this in-depth analysis of the capital asset pricing model (CAPM), the author concludes that despite some faulty assumptions, it still should be used; but only with a clear understanding of its limitations and a knowledge of other more realistic constraints that could be used.
• Bernardo, A., Chowdhry, B., & Goyal, A. (2007). Growth options, beta, and the cost of capital. Financial Management (Blackwell Publishing Limited), 36(2), 5–17. Retrieved from Business Source Premier database.
The authors in this article argue that further breaking down the beta into aggregate parts has important implications for determining the cost of capital.
• Cooper, I., & Nyborg, K. (2008). Tax-adjusted discount rates with investor taxes and risky debt. Financial Management (Blackwell Publishing Limited), 37(2), 365–379. Retrieved from Business Source Premier database.
In response to a new interest in tax savings from debt, the authors developed a formula to determine the tax-adjusted discount rate.
• Haug, M., & Hirschey, M. (2006). The January effect. Financial Analysts Journal, 62(5), 78–88. Retrieved from Business Source Premier database.
The fact that an unusually high rate of return on small-capitalization stocks is consistently observed each January is discussed in this article along with the author’s explanation of the occurrence.
• Anderson, J., & Smith, G. (2006). A great company can be a great investment. Financial Analysts Journal, 62(4), 86–93. Retrieved from Business Source Premier database.
In this research, the authors tested the value of a portfolio that only included stocks from companies selected as “most admired” by Fortune magazine and they found that the stocks substantially outperformed the market.
• Statman, M., Fisher, K., & Anginer, D. (2008). Affect in a behavioral asset-pricing model. Financial Analysts Journal, 64(2), 20–29. Retrieved from Business Source Premier database.
In an attempt to understand investor behavior, the authors developed a behavioral asset-pricing model to determine the effect that the level of admiration of a company had on investment decisions regardless of actual returns.
Readings
Course Text
•Corporate Finance
?Chapter 13, “Risk, Cost of Capital, and Valuation”
This chapter extends the basic model of the cost of capital to include the costs, risks, and budgeting associated with both equity and debt capital. There is also a discussion on the determination of beta in real-world companies.
?Chapter 14, “Efficient Capital Markets and Behavioral Challenges”
This chapter describes the value associated with certain corporate financial decisions and how the different market efficiencies play a role in the decision-making process.
SAMPLE ANSWER
When the money is put in the market, the aim is to generate more profits in return for the capital invested (Markowitz, 2005). In addition to making profitable returns, the investors in the market also try to outshine other markets. If the US markets became less efficiency there would then be fewer returns on average and very high volatility when it comes to the countries investors. The liquidity would not be able to impend the market approach and this would end up changing efficiency in terms of production of goods and services (Bernardo et al, 2007). On the other side, if US market became less efficient, then there would be no accurate information on market issues and there benefit in the market would be very low. When the market is not efficient, the market would become very unpredictable for investment and this is likely to affect the rate of investment. In return, this will affect the market prices, which in turn affect the rate of investment (Cooper & Nyborg, 2008). Inefficiency in the US market would likely lead to the market failure, which would negatively affect the allocation of goods and services. When the market fails, there will be under provision of goods and services due to lack of public goods and the abuse of monopoly power by few business leaders.
The United States market is likely to become inefficient due to lack of public goods, which would affect the cost of production of goods and services (Haug& Hirschey, 2008). When these goods are under produced, the affect the forces of demand and supply that in turn results into market inefficiency. The United States market is also likely to become inefficient due to environmental concerns since the success of the market depends on the sustainable development. Since merit goods holds an important part in the United States economy, underproduction of the merit goods is likely to result into negative externalities that would affect the quality of education, healthcare, and other important segments of the economy (Statman et al, 2008). Similarly, overproduction of demerits goods is also likely to result in market inefficiency. Some of the demerit goods that can negatively affect the United States market are the overproduction of goods such as alcohol, cigarettes, and prostitution. Market inefficiency in the United States can also result from the abuse of monopoly power by big corporations as they can easily manipulate output in their greed to realize huge profits from their customers (Anderson & Smith, 2006). Moreover, the United States market inefficiency can also result from negative and positive externalities that arise from the spillover effects that are related to the production and consumption of the goods and services in the market.
When compared with other markets around the globe, the American market seems more efficient that most developed markets. There is a big difference between the average wealth growth in the American markets compared to other developed market such as China, Germany, and Britain. The United States market contains a list of most admired companies such as Apple, Microsoft, Wal-Mart, among others that enjoys the benefits of their market efficiency. In this regard, most of these American companies outperform the S&P 500, regardless of the day the stocks are being purchased (Cooper & Nyborg, 2008). Therefore, this is a clear indication of the market efficiency that focuses on the intangibles that don’t show up in the company’s balance sheet.
References
Anderson, J., & Smith, G. (2006). A great company can be a great investment. Financial Analysts Journal, 62(4), 86–93.
Bernardo, A., Chowdhry, B., & Goyal, A. (2007). Growth options, beta, and the cost of capital. Financial Management (Blackwell Publishing Limited), 36 (2), 5–17.
Cooper, I., & Nyborg, K. (2008). Tax-adjusted discount rates with investor taxes and risky debt. Financial Management (Blackwell Publishing Limited), 37(2), 365–379.
Haug, M., & Hirschey, M. (2006). The January effect. Financial Analysts Journal, 62(5), 78–88.
Markowitz, H. (2005). Market efficiency: A theoretical distinction and so what? Financial Analysts Journal, 61(5), 17–30.
Statman, M., Fisher, K., & Anginer, D. (2008). Affect in a behavioral asset-pricing model. Financial Analysts Journal, 64(2), 20–29.
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