High Stock Returns in Efficient Markets \"An

High Stock Returns in Efficient Markets

"An efficient market is where market prices are an unbiased estimate of the true value of the investment" (Market Efficiency-Definitions and Tests). Market efficiency only requires that errors in market price be unbiased, not the market price to equal true value every time. Overvalue or undervalue of stock is random in an efficient market. There is an equal chance that stocks are overvalued or undervalued at any point in time.

Profit opportunities presented by overvalued and undervalued stock motivate investors to trade, which moves stock toward its intrustic value (Jones). Changes in stock prices in an efficient market should be random. Investors cannot earn abnormally high returns on stock in an efficient market when prices reflect the intrustic value.

If the stock market is efficient, some people can make very high returns by purchasing the stock at under the value of the intrustic stock price and selling the stock at an overvalued price. Once the stock is purchased at the undervalued price, the purchase of the stock moves the stock price toward the intrustic value because of the trading. It is extremely unlikely that all markets will be efficient to all investors, but it is possible for the market to be efficient to an average investor. It is also possible that some markets will be efficient while some will not. Or, it is possible for the some markets to be efficient for some investors and not to others. Markets become efficient by investors sensing bargains and putting schemes into effect to beat the market. This is the reason that some people may make high returns on stock where others will not.

It would be more difficult to reconcile very high returns with efficient markets if the same people made extraordinary returns year after year. Where the stock prices are random in an efficient market, the investors would need to be consistently looking for bargain stock and not necessarily staying in the same market of stocks. Also, when investors trade the stock price moves toward the intrustic value is another reason an individual stock would not repeat high returns year after year. Once the stock price moves to the intrustic value, purchasing the stock would not produce extraordinary high value.