Questions of Chapter 1

[Barb37]

I just read through Chapter 1 and there are a few things I am not clear about. Hope someone could help.

1) On page 5, "If insider trading does not occur, then the strong form efficient market hypothesis cannot hold as there is then no mechanism by which security prices can incorporate inside information".
- If the market is strong form efficient, then it already has all the info, so what is the point of insider dealing. I mean insider dealing should not exist at the first hand.
- Does this sentance inplies that in a strong form EM, rules are not allowed for insider trading? (if there are rules, then wont have insider dealing which mean strong form EMH cant hold.)

2) I am confused about the definition of fundamental analysis.
on page 4, "if strong form MH holds, fundamental analysis based on all information(both public and private) is ineffective" but in the summary session "2. semi-strong from, .... if market is Semi-strong efficient fundamental analysis cannot be used to generate excess risk-adjusted return", I think this implies that fundamental analysis only has publicly available info.

I think this two sentances contradict, and I dont whether the funda analysis includes the private info or not. Help !!!

Many thanks

 

[ActStudent]

Hi Barb37,

My answers are below:

I just read through Chapter 1 and there are a few things I am not clear about. Hope someone could help.

1) On page 5, "If insider trading does not occur, then the strong form efficient market hypothesis cannot hold as there is then no mechanism by which security prices can incorporate inside information".
- If the market is strong form efficient, then it already has all the info, so what is the point of insider dealing. I mean insider dealing should not exist at the first hand.

You are right, if the market is already strong fom efficient, there's no benefit doing insider trading. But wait, how does the private information feed into the share price? By definition, it feeds into the share price by insider trading! So there should've already been plenty of insider trading done, so that all private information gets reflected in the share price.

- Does this sentance inplies that in a strong form EM, rules are not allowed for insider trading? (if there are rules, then wont have insider dealing which mean strong form EMH cant hold.)

I think insider trading should be allowed to achieve a strong form efficient market. Or if it's not allowed, there should be a way that some people manage to do inside trading.

2) I am confused about the definition of fundamental analysis.
on page 4, "if strong form MH holds, fundamental analysis based on all information(both public and private) is ineffective" but in the summary session "2. semi-strong from, .... if market is Semi-strong efficient fundamental analysis cannot be used to generate excess risk-adjusted return", I think this implies that fundamental analysis only has publicly available info.

I think this two sentances contradict, and I dont whether the funda analysis includes the private info or not. Help !!!

Many thanks

My guess is that it doesn't include private information, but I'm not sure.

 

[Graham Aylott]

I agree that this isn't entirely clear.

Unless stated otherwise, and certainly for the purpose of the CT8 exam, I would always assume that fundamental analysis is based on publicly available information only - so that it cannot generate excess risk-adjusted returns if markets are semi-strong form efficient.