Efficient Market Theory / Hypothesis:

Efficiency in the context of stock market means informational efficiency. It does not mean
operational or organizational efficiency. According to the concept, an efficient stock market
is one which efficiently uses all of a specified set of information in pricing securities. The
reaction of the market is instantaneous. This means that as soon as a piece of information is
available to the market, it is immediately incorporated into security prices. The idea, that the
market uses information efficiently in setting prices of securities has been recognized as the
efficient market hypothesis (EMH). The EMH is applicable not only to the stock market but
also to other segments of the financial markets.

The modern literature concerning the EMH owes its origin to an article published by
Samuelson in 1965.The idea of Samuelson was further extended by Fama. In fact it is the
Fama’s survey work conducted in 1970 which initiated the beginning of modern literature on
the EMH. The matter was again taken up by him in 1991. One of the important implications
of the EMH is that an investor should not be able to make any profit on a specified set of
information which is already available in the market. This happens so because by the time the
buyer or seller of a security is ready to take-up any action, price adjustments have already
taken place.

The function of a stock market is to allocate or channelize the private savings or domestic
savings into the most productive investment area of the economy. In order to perform such
function properly, the market should be an efficient market. The efficiency of a market is of
two types: a) Operating Efficiency and b) Pricing Efficiency

Operational Efficiency denotes whether transactions can be made in the market with
maximum lease and minimum function (disturbances). Such efficiency in indicated by low
transaction cost and high liquidity of the market. On the other hand, the pricing efficiency of
a market is determined by the following criterion:

a) Large numbers of buyers and sellers in the market.

b) Free availability of all relevant information to all buyers and sellers in the market.
c) All investors are aware of the effect of available information on current stock price is
the market.
d) Current price quickly and accurately incorporate all available information is the
market.
e) No investors is there in the market having monopoly over any special information so
that he can consistency that the market to make abnormal/supernormal gain through
that information.

The market efficiency can be categorised into three levels/forms as follows – a) Weak form
of market efficiency. b) Semi strong form of market efficiency, c) Strong form of market
efficiency.
a. weak form of market efficiency:
Under weak form of market efficiency current price fully reflect the information
contained in least price series of records and hence it is useless to predict future price
on the basis of past price information. So it is similar to random well hypothesis.

b. Semi strong form of market efficiency:

Under semi strong form of market efficiency, current prices fully reflect not only past
price related information but also all especially available information (e.g. expense,
earning, dividend interest related charges etc). In this case those investors who are
having private /insider information can be at the market for earning abnormal gains.

c. Strong form of market efficiency:

Under strong form of market efficiency current price fully and accurately reflect all
relevant information-public as well as prices.
In this case, no opportunity id there for any investorsto earns supernormal profit by
having monopoly over any special information.