ACF5130 Chap.2 Market Efficiency and Price Reactions
Market Efficiency and Price Reactions
Market Efficiency and Price Reactions asks what information a traded price already reflects. Weak-form efficiency covers past prices and returns, semi-strong efficiency covers public information, and strong-form efficiency also includes private information.
The chapter shows why prices react to surprises rather than absolute results, how information quality changes the weight investors assign to news, and why a fast price response is evidence of incorporation rather than proof that price equals intrinsic value. Analysis therefore begins with the information set and prior expectation at the event date.
A positive accounting number can still disappoint if investors expected more, while credible guidance can outweigh a current-period result. The chapter separates evidence about response speed from claims about valuation accuracy, tests alternative explanations for later drift, and asks what new observation would weaken the preferred interpretation.
That structure supports cautious, falsifiable conclusions instead of hindsight narratives.
What this chapter covers
- 01
Weak-form information
- 02
Semi-strong information
- 03
Strong-form information
- 04
Expectation surprises
- 05
Announcement timing
- 06
Conditional efficiency claims
Worked example · free
Interpret a mixed public announcement
- +2Identify the separate surprises: revenue is favourable, while margin and persistent cost guidance are unfavourable.
- +2Translate the margin and cost news into weaker expected future cash generation rather than focusing on revenue alone.
- +1Treat the immediate reaction as consistent with public information entering price quickly.
- +1Avoid claiming the exact price change is intrinsically correct; later drift and revised forecasts remain relevant tests.
Key terms
- Weak-Form Efficiency
- Weak-form efficiency means current prices already reflect information contained in past prices and returns.
- Semi-Strong Efficiency
- Semi-strong efficiency means current prices reflect publicly available information as it becomes available.
- Strong-Form Efficiency
- Strong-form efficiency means prices reflect public and private information, including knowledge held by insiders.
- Information Set
- An information set is the defined category of facts assumed to be incorporated into price.
- Expectation Surprise
- An expectation surprise is the difference between what investors anticipated and what new information reveals.
Market Efficiency and Price Reactions FAQ
Does market efficiency mean prices are always correct?
No. Efficiency concerns how quickly and fully a defined information set enters price. Investors can still disagree about persistence, future cash flows or risk, and prices can depart from an analyst's estimate of intrinsic value.
Why can good results produce a falling share price?
Markets respond to surprises relative to expectations and to forward-looking implications. A company may improve on last year yet disappoint a higher forecast, or current results may be strong while guidance signals weaker future margins or growth.
Which efficiency form concerns insider information?
Strong-form efficiency includes private information and would imply insiders cannot earn abnormal returns from it. Semi-strong efficiency covers public information only, so undisclosed managerial knowledge does not directly refute the semi-strong form.
Assessment move
Build a three-row table for the weak, semi-strong and strong forms, listing the information set, implication and typical test. For announcement questions, avoid labels such as good or bad until you write the market expectation and the surprise. Split mixed releases into current performance, forward guidance and information credibility. Then explain how each item changes expected cash flows or risk.
Practise cautious conclusions: immediate repricing is consistent with rapid incorporation of public information, while later drift can question completeness. Keep hindsight out of the event-date analysis by using only information available at that time. End with a testable next step such as forecast revisions, post-event drift or later independent confirmation.
Create an event worksheet with four boxes: prior expectation, public release, price response and later evidence. Fill the first three boxes using only event-date information, then use the last box to judge whether incorporation was complete without rewriting history. Drill classification prompts by changing only the source of information.
A price chart belongs to weak form, a published report belongs to semi-strong form and a private board discussion raises the strong-form issue. When evidence quality differs, explain why investors may rationally weight an allegation, a management response and an independent confirmation differently even though all become public.
Compare two possible conclusions after every case: one about the speed of incorporation and another about intrinsic value. Keeping them separate prevents a fast response from becoming proof of correct pricing. For revision, write one sentence that would falsify your preferred reading, such as predictable drift without new information.
This habit turns an abstract theory into an evidence test and produces balanced assignment prose.
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