Forms of efciency Attempts to assess efciency have addressed themselves not so much to whether the capital markets are or are not efcient but rather to what extent they are efcient. Roberts (1967) suggested that efciency and tests of it should be dealt with under three headings: l Weak form. If the market is efcient to this level, any information that might be contained in past price movements is already reected in the securities prices. l Semi-strong form. This form of efciency implies that all relevant publicly available information is impounded in security prices. l Strong form. If present this would mean that all relevant information, including that which is available only to those in privileged positions (for example, managers), is fully reected in security prices. These are ascending levels of efciency such that, if a market is strong-form efcient it must, therefore, also be semi-strong and weak-form efcient. Approach taken by the tests

Propositions such as that relating to capital market efciency are not directly testable. How can we test whether all available information is reected in security prices? The researcher may not personally have all of the available information or even know that some of it exists. We can, however, test whether or not security price behaviour seems consistent with efciency. Generally, the tests that have been carried out have tried to do this. The tests have sought to assess whether or not it seems possible to make abnormal returns by exploiting any possible inefciency. Abnormal returns in this context means returns in excess of those that could be made, over the same period in which the test was conducted, from securities of similar risk. Returns typically means capital 259 BUSF_C09.qxd 11/19/08 10:14 Page 260

Chapter 9 The secondary capital market and its efciency gain plus dividend received over a period, expressed as a percentage of a securitys price at the start of that period. Tests of this type pose several methodological problems. Such is the number of factors acting simultaneously on the price of a particular security that it is difcult to know to what extent prices are affected by the specic factor in which the researcher is interested and to what extent other factors are involved. For our present purposes, let us accept what most qualied observers believe, that the major researchers in this area, some of whose work we shall consider, have sufciently well overcome the practical problems for their results to be regarded as providing signicant insights. Where this seems not to be the case, we shall discuss it. Readers who are interested in looking at the methodological problems in detail should take up some of the references given during and at the end of this chapter.

Tests of weak-form efciency Technical analysis It has long been popularly believed that security prices move in cycles or patterns that are predictable by those who study the matter closely enough. Many feel that past patterns of security price behaviour repeat themselves, so that spotting a repeat starting to occur can put the investor in a position to make abnormally large investment returns. Not surprisingly, adherents to this philosophy use graphs and charts of past security prices to facilitate recognition of the pattern early enough to benet from it. These people are often referred to as chartists.