Equity Markets and Economic Development: What Do We Know

managerial efficiency by promoting competition through effective takeover or threat of
takeover (Jensen and Meckling 1976).

Overall, this analysis suggests that equity markets are useful as they enhance the economy’s
allocative efficiency. However, the analysis becomes more complex when one incorporates
information costs and the informational requirements it imposes on the individual equity
investor ((Oshiloya&Ogbu, 2003). Just like credit markets, equity markets can be subject to
informational constraints which may undermine their allocation function.

1.2 The impact of market efficiency

1.2.1 Definition

At the theoretical level, ‘market efficiency’ states that the pricing of securities reflect all
available information that is relevant to their valuation (Fama, 1970). However, within this
unifying framework, ‘weak form’ efficiency has to be distinguished from other more
restrictive definitions of efficiency, such as ‘strong’ and ‘semi-strong’ efficiencies. ‘Weak-
form’ efficiency states that asset prices reflect all past available information relevant to their
valuation, so that the analysis of past prices cannot help predicting future patterns. ‘Semi-
strong form’ efficiency states that prices incorporate all public information as published in
specialized press, financial statements and analysts’s reports. Finally, ‘strong form’ efficiency
states that all public and private historical information is entirely reflected within asset prices,
implying that even insiders are unable to achieve abnormal rates of returns by predicting
future values. Nonetheless, rejection of the weak form of efficiency automatically implies
rejection of the ‘semi strong’ and ‘strong’ forms. The weak form definition of market
efficiency thus constitutes the main operational tool for theoretical and empirical studies
(Mobarek & Keasey, 2000). It implies that prices incorporate all known or anticipated events,
and thus constitute an unbiased estimation of an asset’s intrinsic value. The main consequence

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