Investors differ with regard to the degree of risk involved in a particular investment. According to Madura, it is the investor’s objective to balance their returns with the degree of risk involved in a particular investment. In most cases, investors have a preference for high returns and low risk. An efficient market refers to a market whereby the existing market prices represent an unbiased estimate of a particular investment’s true value. Alternatively, an efficient market refers to a market where there is an efficient and effective flow of information regarding investment. In addition, the information is reliable and easily accessible in the market. In an efficient market, investors can use current indicators such as the price of a particular security to forecast its future performance.
An efficient market is characterized by a considerable number of active investors. According to Tatum, trade within an efficient market takes place with a high degree of confidence. This arises from the fact that there is sufficient knowledge regarding the returns of each transaction. As a result of the reliability of the information in an efficient market, it is easy for an investor to minimize the variation between the expected return and the risk involved.
According to Chisholm, there are various forms of market efficiency, which include weak, semi-strong, and strong forms.
Weak-form
Ma asserts that the present prices of securities give a true reflection of all the historical prices.
Semi-strong form
On the other hand, Ma asserts that the securities’ prices incorporate all the market information in a semi-strong market.
Strong form
Baker and Nofsinger are of the opinion that the market information which is publicly available and which is not is well reflected by the securities’ prices.
If all investors believe the market to be efficient, the investors will not look for any form of market inefficiencies. This means that the investors would not be concerned with analyzing the securities. The resultant effect is that the market would become inefficient again. According to Ziemba and Ziemba assert that efficient markets are dependent on the number of participants who are the opinion that the market is characterized by a high degree of inefficiency.