Question

Can you please assist me explaining what it means to have an efficient capital market? More specifically, can you please provide context and explanations as to the behavioral challenges in achieving efficiency, the three forms or kinds of market efficiency, the implications they have to corporate finance, and whether you would or not you would consider the real estate market an efficient capital market?

Answer 1

An efficient capital market is one which automatically adjust the price of products with demand and supply. In an efficient capital market, the allocation of funds is efficient, the cost of transaction is minimal and any new information is very quickly adjusted in the price of the product and the asset price can be readily determined. There are basically three forms of efficient market hypothesis, weak form efficiency, semi strong form efficiency and strong form efficiency. The weak form states that prices of the traded assets already reflect all past publicly available information. The strong form states that price reflect past information as well as prices change to new publicly available information. The strong form says that price reflect even hidden or insider information. The behavioral challenges in achieving efficiency lies in the fact that there should be large number of buyers and sellers, regulator should be efficient and information should be available to everybody. The implication of high efficiency in the capital market is it reduces the cost of transaction and asset prices reflect the true value. Real estate market is not that efficient. One main reason is the price reflected in the market is not always updated very frequently, they are stale prices. The transaction cost in real estate market is significant comparison to the equity market.