Market Types

Market Types
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Introduction
Weak Form
Semi-Strong
Strong-Form

We have already discussed the fact, that investors behave differently, according to the information presented to them.

We shall now discuss the financial markets in terms of how efficient they are, to react to share prices.

The weak form of market, is one where you cannot predict how shares will behave using historical data, the market is seen as not operating efficiently. The market has a very weak reaction to any information that is released. Shares are seen as going on a 'random walk' not behaving in a rational manner.

The bulk of tests done on the weak form markets, have looked at the correlations between successive returns on share. The tests have showed:

EUGENE FAMA - Fama's work was done in 1965. Fama's work was based on several one-day tests. Fama showed that there were significant correlations in 10 out of 30 shares. Fama's work suggested there was no connection between the correlation in one test against another, the results were independent.

BRUNO SOLIWIK - Soliwik showed in his tests, that markets did not always behave in an un-rational manner. Soliwick suggested that it takes time for the markets to react to information presented to them.

DRYDEN - Dryden reported on a comprehensive range of random walk tests. In fact he observed 15,000 shares. His findings showed there were no significant evidence for any one or two day persistent price change, in other words share value remain constant.

GRIMES & BENJAMIN - Tested 600 observations between 1968 and 1971. Their results concluded the possibility of random share values increased with the size of a company.

SEMI-STRONG

In the semi-strong model, the market does react to information that is released. The semi-strong model maintains that share prices contain most of the available information, thus the share price should reflect information, however the semi-strong markets do accept not all the information is released, insider trading does occur.

The tests carried out on the semi-strong model are based on using stock splits. Stock splits can be described as new share issues for existing shares.

FAMA - Fama looked into 940 splits, his results suggested that splits occurred generally good economic periods. He contended that the splits had little affect on market valuations.

FIRTH - Where Fama's work was based on wall street, Firth looked at the LSE. Firth found shares behaved better before a new issue was announced.

BALL & BROWN - Developed the Abnormal Performance Index (API). This model avoids the complication of assuming people will invest an equal amount in shares. Their results found share values were better when the companies reported better profit, whilst poor performing companies saw poorer share values. This was consistent with the semi-strong perspective that investors, given information will react logically to an investment.

STRONG FORM

The strong form of market is one where all information regarding shares is known and reflected in the share values. Any new information released is instantly reflected in the share values.

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