Capital Market Efficiency

Capital market history suggests that the market values of stocks and bonds can fluctuate widely from year to year. Why does this occur? At least part of the answer is that prices change because new information arrives, and investors reassess asset values based on that information.

The behavior of market prices has been extensively studied. A question that has received particular attention is whether prices adjust quickly and correctly when new information arrives. A market is said to be "efficient" if this is the case. To be more precise, in an efficient capital market, current market prices fully reflect available information. By this we simply mean that, based on available information, there is no reason to believe that the current price is too low or too high.

The concept of market efficiency is a rich one, and much has been written about it. A full discussion of the subject goes beyond the scope of our study of corporate finance. However, because the concept figures so prominently in studies of market history, we briefly describe the key points here.

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