PDF Ebook Investigation of Market Efficiency
Most developed countries around the world have enacted laws prohibiting insiders from trading based on non-public information in order to establish a market environment where security trading is a fair game for all participants. However, the numerous empirical analyses that have focused on insider trading have consistently documented that portfolios which are constructed on the basis of the trading behavior of insiders generate abnormal profits. These abnormal profits, which are the result of insider’s prior access to knowledge about public information events, indicate the existence of an inefficient market.
In an efficient market all available information relevant to the pricing of securities must be rapidly reflected in the prices of the securities. The arguments of Fama (1965) form the theoretical foundation for the Efficient Market Hypothesis, which persuasively reasons that in an efficient and active market consisting of many well informed investors, equity prices will appropriately reflect the effects of information based on present and future expected events. The strong form of the hypothesis asserts that the current market prices fully reflect all private (insider) and public information. In other words, insiders should not be able to earn excess returns from privileged asymmetric information. The strong form of the hypothesis represents an absolute standard, and in practice, it is more likely that markets will exhibit only a certain degree of efficiency.
The previous studies on insider trading display the ability of insiders to make abnormal profits, thus refuting the strong form of the Efficient Market Hypothesis. Among these prior efforts, however, the majority have primarily focused on U.S. capital markets, and thus, their conclusions may not be applicable to security markets in other parts of the world. In addition, very little research of the same nature has been conducted on Asian markets, especially the financial markets of Hong Kong. Accordingly, this paper seeks to fill this gap by focusing on the Stock Exchange of Hong Kong (SEHK).
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