Efficient Securities Market

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EFFICIENT SECURITIES
MARKETS
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[PLO 3] Menguasai konsep dan teknik penyusunan

informasi akuntansi dan memanfaatkan teknologi
informasi dan mengkomunikasikan hasilnya
[CLO 1] Mampu memahami dan menjelaskan konsep
konsep teori akuntansi untuk pengambilan keputusan.
[Sub CLO 1.6] Mampu memahami dan menjelaskan konsep
efficient
securities market dan asymetri information pada
akuntansi
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Efficient Securities Markets
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Efficient Securities Markets
Definition (Semi-strong form)

 At all times, market price of a security fully reflects all
publicly available information about that security
Characteristics of market efficiency

 Security prices do not reflect inside information
 Efficiency is a relative concept, defined relative to a stock
of publicly available information
 Investing is a fair game—no bargains
 Security prices fluctuate randomly over time
Efficiency is a theoretical ideal

 The question of how close actual security markets are to
this ideal (discussed)
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Accounting Implications of Securities

Market Efficiency
W. Beaver, “What Should Be the FASB’s

Objectives,” Journal of Accountancy
(1973)
 Full disclosure, incl. acc. policies
 Accounting policies do not matter (unless cash flow
effects)
 “Naïve” investors price-protected
 Accountants in competition with other information
providers
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The Informativeness of Price
If market is fully efficient, share prices fully

reflect all publicly available information.
That is, prices are fully informative about
value
 If share prices are fully informative, noone would bother to
gather information, since can’t beat the market (fair game)
 If no one gathers information, share prices will not reflect
all publicly available information
 If share prices do not reflect all publicly available
information, investors will gather information. Share price
will quickly become fully informative
 Then, noone would bother to gather information, etc., etc.
 Hence a logical inconsistency
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The Informativeness of Price (continued)
A way out of the logical inconsistency

Noise trading
Expected value of noise = 0
Share prices still efficient, but in an expected value sense
Share prices are partially informative in presence of noise
trading
Share price may deviate from its efficient value due to noise
trading
Restores incentive of investors to gather information
>> Continued
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4.5 A Capital Asset Pricing Model
CAPM
E(Rjt) = Rf(1 - βj) + βjE(RMt)
Market sets share price so that expected return E(Rjt)
(i.e., firm’s cost of capital) is given by right side of
equation
Note that only firm-specific component is ßj
How is expected return defined? See Equation
(4.2) in text:
>> Continued
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Concept of a Security’s Beta
• Beta measures the covariance of security’s

return j with market portfolio return M
βj = Cov(j, M)/Var(M)
• Measures risk contributed by a security to a

fully diversified portfolio
• Var(M) is the variance of the market portfolio
(A standardization device so that betas from securities
traded on different markets can be compared)
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A Capital Asset Pricing Model (continued)
How does accounting information affect

share price?
 In Equation (4.2), accounting information affects
the numerator E(Pjt + Djt)

 E(Rjt) does not change, since only firm specific
component in CAPM is beta
 Thus Pj,t-1 (i.e., current share price) must change in the
denominator of Equation 4.2 to keep (Ejt) unchanged
>> Continued
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A Capital Asset Pricing Model (continued)
Critique of the CAPM

• CAPM assumes rational expectations
Investors assumed to know beta
In practice, investors do not know beta, so must estimate it,
creating estimation risk
• CAPM assumes common knowledge
Everyone knows that everyone knows beta, etc.
This rules out sophisticated investors’ ability to take advantage
of ordinary investors who have inferior knowledge of beta
• CAPM assumes no transactions costs and liquid markets
• CAPM assumes rational investors
• Despite these limitations, CAPM is a good place to start to
appreciate the role of information in capital markets
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Information Asymmetry
The fundamental value of a share

• The value of a firm’s share on an efficient market if all
information about the firm is publicly available (i.e., no
inside information)
Inside information
• Information about the firm that is not publicly available
Continued
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Information Asymmetry (continued)
Investor reaction to inside information

• Inside information another source of investor estimation
risk
• The lemons problem (Akerlof (1970))
• Would you buy a used car from someone you do not know?
• If so, how much would you pay?
• Would you buy a share in the presence of inside
information?
• No, withdraw from market, market collapses (e.g., post-Enron,
post 2007-08 market meltdowns), or
• Yes, but pay less, to protect against estimation risk
Continued
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Effect of estimation risk on share prices

• Efficient market price includes a “discount” for
expected estimation risk (i.e., for expected losses at the
hands of insider trading)
• In effect, investors demand a higher return
• Then, CAPM may understate cost of capital, since
ignores estimation risk
• To some extent, estimation risk may be diversified away,
but, since outside investors more likely to lose than gain
from insider trading, some discount will remain
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Continued
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• Controlling estimation risk

• Insider trading laws
• Financial reporting
• Role of financial reporting is to convert inside information
into outside, thereby reducing estimation risk
• Cannot eliminate all inside information.

Why?
• Definition of markets that “work well”
• Low estimation risk, share prices as close to
fundamental value as is cost effective
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A Graphical Illustration of Estimation

Risk
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Social Significance of Markets that

Work Well
• In a capitalist economy, allocation of scarce capital to competing
demands is accomplished by market prices
• Firms with productive capital projects should be rewarded with high
share prices (low cost of capital) and vice versa
• Capital allocation is most efficient if share prices reflect
fundamental value
• Society is better off the closer are share prices to fundamental value
(i.e., if markets work well)
Continued
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Social Significance of Markets that

Work Well (continued)
• Social role of financial reporting

• To help markets work well
• Maximize amount of publicly available information
• Subject to a cost-benefit constraint
• Social role of financial reporting is enhanced

by securities markets efficiency
• Then, market fully uses financial accounting information
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1

[PLO 3] Menguasai konsep dan teknik penyusunan

Efficient Securities Markets

Efficient Securities Markets

Definition (Semi-strong form)

Characteristics of market efficiency

Efficiency is a theoretical ideal

Accounting Implications of Securities

W. Beaver, “What Should Be the FASB’s

The Informativeness of Price

If market is fully efficient, share prices fully

The Informativeness of Price (continued)

A way out of the logical inconsistency

4.5 A Capital Asset Pricing Model

Concept of a Security’s Beta

• Beta measures the covariance of security’s

• Measures risk contributed by a security to a

A Capital Asset Pricing Model (continued)

How does accounting information affect

the numerator E(Pjt + Djt)

A Capital Asset Pricing Model (continued)

Critique of the CAPM

The fundamental value of a share

Information Asymmetry (continued)

Investor reaction to inside information

Information Asymmetry (continued)

Effect of estimation risk on share prices

Information Asymmetry (continued)

• Controlling estimation risk

• Cannot eliminate all inside information.

A Graphical Illustration of Estimation

Social Significance of Markets that

Social Significance of Markets that

• Social role of financial reporting

• Social role of financial reporting is enhanced

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