Kaplan Schweser’s responses are making me more confused (lol). Anyway, how on earth does this explanation make sense? I understand that semi strong reflects all publicly available info, but Kaplan goes on and says “If the semi-strong form of EMH is violated, the strong form of EMH is also violated.” Huh? Strong form includes private data. Very confused here. Maybe its just a bad question unless I’m looking to far into this?
An analyst with Guffman Investments has developed a stock selection model based on earnings announcements made by companies with high P/E stocks. The model predicts that investing in companies with P/E ratios twice that of their industry average that make positive earnings announcements will generate significant excess return. If the analyst has consistently made superior risk-adjusted returns using this strategy, which form of the efficient market hypothesis has been violated?
- Weak form only.
- Semistrong and strong forms only.
- Strong, semistrong, and weak forms.
Explanation: The sem-istrong form of EMH states that security prices rapidly adjust to reflect all publicly available information. If the analyst can use his model, which is based on publicly available information, to earn above average returns, the semi-strong form of the EMH has been violated. If the semistrong form of EMH is violated, the strong form of EMH is also violated.
In very broad terms:
Weak efficiency = share prices reflect all historical information
Semi-strong efficiency = share prices reflect all historical information + reflect all publicly available information
strong efficiency = share prices reflect all historical information + reflect all publicly available information + reflects all information held privately by the directors
In other words, semi-strong is not JUST publicly information, it is the continuation of the weak (it includes the weak efficiency AND is further expanded by publicly available information).
By the same logic, the strong efficiency (includes the weak efficiency AND the semi-strong efficiency AND is once again expanded by the privately held information).
If semi-strong efficiency is broken, the the strong efficiency must be as well!
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