Market efficiency Financial theorists have identified two different types of efficiency in financial markets. The first, informational efficiency, contributes to the existence and strength of the other, economic efficiency. The degree of informational efficiency exhibited by a market refers to the types of information incorporated into the prices observed in the market and the speed with which prices adjust when new relevant information is released into the market. Markets are said to exhibit one of three levels of informational efficiency: weak-form efficiency, semistrong-form efficiency, or strong-form efficiency. At any level, a market’s informational efficiency is likely to be stronger when there is a number of market participants receiving and analyzing relevant security and market information in search of the most profitable investments. The potential for a security to generate returns is what generates a profitable investment, since these returns result from price increases and decreases that are larger than they should be based on the riskiness of the investment. True or False: The degree of economic efficiency observed in a market is strongly influenced by the degree of informational efficiency that exists in the same market. False True

1. Large

2. Abnormal

3. True

Explanation:

1. At any level, a market’s informational efficiency is likely to be stronger when there is a Large number of market participants.

When there is a larger number of participants, this means that there is a large number of people able to acquire and analyse information about securities and the financial markets.

As a result of this, information is more wide ranging and easily available such that they market has very good information efficiency.

2. The potential for a security to generate Abnormal returns is what generates a profitable investment.

When a security is potentially able to generate abnormal returns, there is a chance of making very profitable returns if those returns are higher or lower than estimated. When returns are estimated, these are usually reflected in the market price already because they are expected, when the returns are better or worse than expected though, this means that the prices were wrong therefore giving a chance of a positive gain on the security.

3. True.

Information efficiency is very important in the market. It can mean the difference between the market being manipulated and used for unfair gains and the market being used fairly by all. Information efficiency gives every market player the same Opportunity to find out about a security and act accordingly instead of select people taking advantage of hidden Opportunities.

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