Market Efficiency

Here is a practice question where I don’t understand the answer.

[question removed by moderator]

If share prices reacts gradually to public release of annual report, doesn’t this mean that the market where the share trades its informationally inefficient? The answer explains that gradual changes must be from the release of additional information, but doesn’t explain why… Can someone be kind enough to explain why gradual price adjusting indicates that market is receiving additional information about the company? Does this have anything to do with insider trading?

Inefficiency (weak, semi-strong or strong) is whether your portfolio is earning constantly (on average) abnormal profits/risk-adjusted return, that is, beating the market (alpha return), but the difference remains if the market reflects fully all current market information (weak form market efficiency), if the market fully reflects all public information (semi-strong), or if the market fully reflects private + public information (strong-form). If you beat the market constantly using technical analysis (past volume and prices serve to beat the market) there is no weak form of efficiency (and thus, no semi-strong, nor strong market efficiency) and that is saying that the market does not reflect all market information. If you beat the market constantly using fundamental analysis (ratios, DCF, etc.) then the market does not reflect fully all public information, and your portfolio´s return would be better actively managed, than passively managed, if this semi-strong efficiency breaks, then go on a passive-investment strategy. Finally, because “no group has monopolistic access to all private information”, strong-form market efficiency states that no one should be able to consistently achieve positive abnormal returns, given that if this efficiency were true, we would say that inside trading would be a day-to-day strategy by market participants.

Market participants make forecasts about what they expect about firm´s earnings, cash flows, etc, but the main point is that they make forecast and they are not visioners about what will surely happen in the future. When new information comes in (that is to say, a hurricane, annual reports, tax cuts, etc.) market participants will adjust their models and will take new positions or stand by their old position and that is where the “share price wil gradually react”.

The question states "price reacts gradually to the public release of its annual report" so it’s not new information, but rather an incomplete adjustment to new information. It’s a behavioral bias - if memory serves, either anchoring and adjustment or partial adjustment.