Strong Form Efficiency (Economics) - Explained
What is Strong-Form Efficiency?
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Table of ContentsWhat is Strong Form Efficiency?How does Strong Form Efficiency Work? Origins of the Strong Form Efficiency ConceptExample of Strong Form EfficiencyAcademic Research on Strong Form Efficiency
What is Strong Form Efficiency?
Strong form efficiency refers to a market efficiency in which prices of stocks reflects all the information in a market, be it private or public. In strong form efficiency, stock prices reflect public and private information about a market. Strong form efficiency is the strongest of the three forms of the efficient market hypothesis. The other forms are the weak and semi-strong forms of market efficiency. According to the proponents of the strong form efficiency, the fact that private of insider information about a market is revealed by the stock price does not give investors an edge in the market.
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How does Strong Form Efficiency Work?
There are three forms of market efficiency, the weak form efficiency, semi-strong efficiency and strong form efficiency. The strong form efficiency is one that maintains that securities or stock prices reveal the overall information about a market, whether the information is public or private (insider). The strong form efficiency holds that the overall market is affected by past events of market history and not just random occurrences. In contrast, the weak form efficiency maintains that the overall market is not influenced by past events. That means, current price movements and trends are not affected by past events.
Origins of the Strong Form Efficiency Concept
The strong form efficiency was developed by Burton G. Malkiel, a Princeton economics professor. He developed the concept in 1973 in his book titled "A Random Walk Down Wall Street." Practitioners of the strong form efficiency believe that public and inside information about the market that are revealed by stock prices will not give investors an edge in the market. That means that the information disclosed will not benefit investors or give them an advantage. Contained in the 1973 book by Burton G. Malkiel was also the semi-strong form efficiency in which public information about a market are revealed in current market prices.
Example of Strong Form Efficiency
It is important to emphasize that the strong form efficiency is the only version of the efficient market hypothesis that reveal insider information about the market, this is proprietary information. The information will not benefit an investor in terms of getting high returns as a result of the information revealed. For example, the chief technology officer (CTO) of a firm is fully aware that revealing proprietary information such as information about the internal development of rollout of a new product will jeopardize the standard rollout. According to strong form efficiency, if the information is revealed to the public after the product has been released, the stock price of the company will not be affected by the insider and public information revealed.