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What Are the Characteristics of an Efficient Capital Market?

An efficient capital market is marked by rapid information dissemination, where prices fully reflect all available data. Investors have equal access, trades execute swiftly, and the market accurately gauges asset values, minimizing arbitrage opportunities. It's a realm where fairness and foresight thrive. Wondering how this impacts your investments? Let's examine the implications for your financial strategy.
John Lister
John Lister

A capital market can be defined narrowly as the market for investors to trade securities, and widely as the market for companies and governments to raise money or capital. An efficient capital market is one where prices change rapidly in response to changes in demand and supply, thus producing "fair" prices at any time. As well as information, an efficient capital market will usually require liquidity through a large enough collection of traders to accurately influence prices.

The capital market consists of securities, both debt products such as bonds and equity products such as stocks. It is usually defined as securities where the issuer will have more than a year to return the initial payment. This means short term securities such as Treasury bills are instead traded on a different type of market, usually called a money market.

Businesses use capital markets like the stock exchanges to raise capital.
Businesses use capital markets like the stock exchanges to raise capital.

There are two main forms of the capital market. The primary market is the one in which companies and governments create and sell the securities, often via an underwriter. The secondary market is the one in which traders buy and sell those securities among themselves, meaning the investor who ultimately redeems a debt security or receives dividends on stocks is often not the investor who originally paid money to the issuer.

An efficient capital market is usually defined by the availability and accuracy of information about the securities and their prices. Economic market theories are usually based on the idea that every trader has full information about the securities available and the price demanded, along with any other details that could be relevant such as past market behavior, the performance of the company issuing the stock, or the likelihood of a debt security issuer repaying the money as promised. The more efficient a capital market, the closer the real situation is to this hypothetical situation. The idea is that the more efficient the market, the more informed the judgments and decisions of investors, and thus the money is allocated in the most productive way overall.

One classification gives three levels of efficiency. A weak efficient capital market is one where only information about the past is reflected in security prices. A semi-strong efficient market is one where the publicly available current information is known by all investors and reflected in prices. A strong efficient market is one where all information is known by investors, even information that is not publicly available; this is effectively the situation assumed by market theories but unlikely in the real world.

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Discussion Comments


@serenesurface-- There actually isn't any capital market in the world that isn't regulated in some way. Technically, governments are not supposed to intervene in the economy but they always do to some degree. And it can actually be in our benefit for the government to do that, although different people have different opinions about it.

Government intervention can sometimes stabilize the economy. But on the other hand, it may allow businesses that actually deserve to go bankrupt to stay afloat in the process, resulting in some unfair competition to other businesses. The US government does this from time to time by saving businesses going bankrupt with government subsidies. Some people think it's a good idea, other's don't. But I can tell you that there isn't a capital market in the world without any kind of government intervention. Is our capital market efficient? Yes, I would say so, although we could be doing a lot better as of 2014.


Is an efficient capital market one that is not supervised or intervened in at all? And do we have an efficient capital market in the US considering that the government does intervene from time to time? Does anyone have any ideas or opinions on this?


Information really has a lot to do with a capital market being efficient. Like the article said, in an ideal situation, all investors have all of the information they need before making their decisions. In today's world, that's almost about right thanks to technology and the availability of vital data.

This is actually thanks to investors who demand that they have all the necessary information. So capital markets have moved in this direction of free flow of information. This is great though because it means that global markets are more stable because of these more accurate decisions by investors.

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    • Businesses use capital markets like the stock exchanges to raise capital.
      By: Oleksiy Mark
      Businesses use capital markets like the stock exchanges to raise capital.