Question

Which is of the following provides evidence of an efficient market or not. Briefly explain your answers. To which form of efficient market are your referring in each: weak form, semi-strong, strong?
a. Active mutual funds outperforming passive ones after adjusting for risk and expenses.
b. Momentum in stock prices over 12 months
c. At the announcement of a positive earnings surprise, the price of stocks jump and continue to rise for a month with no new news.

Answer 1

a. If markets are efficient, there is no way to beat the market (or passive funds). Hence, this does not provide evidence of market efficiency.

b. This too does not provide evidence of market efficiency. The difficulty is that an increase in asset prices, in and of itself, should not warrant further increase. Such increase, according to the efficient-market hypothesis, is warranted only by changes in demand and supply or new information (e.g. fundamental analysis)

c. The increase after the announcement points towards the semi-strong form of efficiency but the stock kept on going up for a month. This like in b (momentum in stock prices) is not an evidence of market efficiency.