CFA Level IEquity InvestmentsEasy
A market analyst states that a particular equity market is strong-form efficient. If this claim is correct, which of the following statements is most accurate?
- AStock prices fully reflect all public and private information, so even corporate insiders cannot consistently earn abnormal risk-adjusted returns.
- BPrices react to new information with a lag, allowing early access to public news to generate abnormal returns.
- CInvestors can earn consistent abnormal returns by analyzing publicly available financial statements.
- DStock prices reflect only historical price and volume patterns, making technical analysis potentially profitable.
Show answer & explanationAnswer & explanation
Correct answer: A. Stock prices fully reflect all public and private information, so even corporate insiders cannot consistently earn abnormal risk-adjusted returns.
Strong-form efficiency is the most stringent form of the efficient market hypothesis: prices reflect ALL information, public and private (including insider information). Therefore, no group of investors — not even insiders — can consistently earn abnormal risk-adjusted returns.
Why the other options are wrong
- B. Slow price adjustment implies inefficiency, the opposite of the strong-form claim.
- C. This describes inefficiency relative to public information, contradicting even semi-strong efficiency.
- D. This describes weak-form efficiency only, not the strong form.
Strong-Form Market Efficiency
A market condition in which stock prices reflect all information — public and private (insider) — so that no investor can consistently earn abnormal returns.
- Strong form subsumes weak-form and semi-strong-form efficiency.
- Implies insider trading would not generate abnormal profits.
- Empirical studies generally reject strict strong-form efficiency (insiders do earn abnormal returns).
Memory trick: Weak sees past, Semi sees public, Strong sees ALL — even secrets.