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strong-form test of efficient markets hypothesis

A few questions on Reading #57 in Study Session 13:

1. Anyone know where the terminology, “weak, semistrong, and strong” comes from?

2. So I get the basic concepts behind weak and semistrong, but on strong, re: the first description below:

How can the stock price reflect information from private sources? what would be an example of this? How can a stock price reflect inside information if by definition, inside information is info known only to insiders, and thus nobody is supposed to be trading on that information?

from Schweser study notes (book 4 page 146):

“Strong form of EMH states that stock prices fully reflect all information from public and private sources. Strong form includes all types of information: market, nomarket public and private (inside) information. This means that no group of investors has monopolistic access to information relevant to the formation of prices, and none should be able to consistently achieve abnormal returns.”

4. Re Strong-Form Tests of the EMH: from Schweser (book 4 page 147): “Academic tests of the strong form look at the legal use of private information.” Under what scenario could one be trading legally on inside information?

5. Re LOS 57.b: Schweser gives six examples of documented market anomalies and says that all six undercut the semi-strong form of EMH. Why the semi-strong? I think of the weak as referring more to technicals and the semi-strong as that plus fundamentals. For example, doesn’t the January effect have more to do with technicals than fundamentals (e.g. because in prior years, stock x and other stocks have tended to trade up, I will make an abnormal by buying in December and selling in January)

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A few thoughts:

From what I remember Fama defined different forms of EMH as weak, semi-strong and strong. Those are very popular terms in math and physics. Semi-strong is a stronger statement than weak (weak is automatically true in semi-strong EMH), and strong is stronger than semi-strong (semi-strong is automatically true in strong EMH).

Strong-Form EMH says that even people who have access to material nonpublic information don’t have an edge (can’t have abnormally high returns for a long period of time). From what I remember tests show that
1) inside information gives an edge, that’s why SEC prohibits trading using inside information
2) specialists who have access to the order book have an edge

I agree that January rule has more to do with the weak form, it has more to do with technicals.

cnd Wrote:
——————————————————-
> A few questions on Reading #57 in Study Session
> 13:
>
> 1. Anyone know where the terminology, “weak,
> semistrong, and strong” comes from?
>
> 2. So I get the basic concepts behind weak and
> semistrong, but on strong, re: the first
> description below:
>
> How can the stock price reflect information from
> private sources? what would be an example of
> this? How can a stock price reflect inside
> information if by definition, inside information
> is info known only to insiders, and thus nobody is
> supposed to be trading on that information?
>
“supposed to be” in the US and other similar markets recently. Tons and tons of insider trading has been done and is continuing to be done.

> from Schweser study notes (book 4 page 146):
>
> “Strong form of EMH states that stock prices fully
> reflect all information from public and private
> sources. Strong form includes all types of
> information: market, nomarket public and private
> (inside) information. This means that no group of
> investors has monopolistic access to information
> relevant to the formation of prices, and none
> should be able to consistently achieve abnormal
> returns.”
>
> 4. Re Strong-Form Tests of the EMH: from Schweser
> (book 4 page 147): “Academic tests of the strong
> form look at the legal use of private
> information.” Under what scenario could one be
> trading legally on inside information?
>
Market specialists is the big one. They know about order flow and are allowed to trade on it.

Nobody believes that markets are strong form efficient. The idea that you can’t make money trading on insider information is ludicrous.

> 5. Re LOS 57.b: Schweser gives six examples of
> documented market anomalies and says that all six
> undercut the semi-strong form of EMH. Why the
> semi-strong? I think of the weak as referring
> more to technicals and the semi-strong as that
> plus fundamentals. For example, doesn’t the
> January effect have more to do with technicals
> than fundamentals (e.g. because in prior years,
> stock x and other stocks have tended to trade up,
> I will make an abnormal by buying in December and
> selling in January)

I’m Da Church of the faithful, I’m Liao Fengyi, clergywoman mother should have to introduce you to me, I have seen you twice, in which time you are more impressed with everyone I guess in the back of the church at noon to eat noodle face!

> Nobody believes that markets are strong form efficient. The idea that you can’t make money trading on insider information is ludicrous.

True, no financial market exists which is strong form, but it is possible to make a market strong form if you allow for insider trading… that is make insider traing legal. Crazy, isn’t it?
I believe it and so does Friedman .
Dreary

If insider trading was legal, that still doesn’t mean that markets are strong form efficient. It just means that it has some hope of being strong form efficient.

I’m Da Church of the faithful, I’m Liao Fengyi, clergywoman mother should have to introduce you to me, I have seen you twice, in which time you are more impressed with everyone I guess in the back of the church at noon to eat noodle face!

True, it does get us closer to strong form, and the question then becomes why not legalize insider trading if it is supposed to do us a major good?
B
e careful not to answer by saying that “.. oh but insider traing is bad”, because that would contradict the fact that allowing insider tading does get us closer to strong form!!
Dreary