Stock market and bond market efficiency can be evaluated within the context of efficient market hypothesis. Overall, both markets may be considered efficient as advances in communication technology allow investors to quickly access and react to market information. In stock markets, investors face significant challenges due to the wide scope of methods and information used to interpret and value stocks. Meanwhile, in bond markets, investors face challenges relating to issues of transparency, subjectivity and liquidity.
Efficient Market Hypothesis
Market efficiency may be defined as the degree to which the value of asset instruments reflects publicly available information. According to efficient market hypothesis theory, the price of any security asset in a liquid market reflects all readily available information at any given time. An investor therefore will not be able to consistently outperform a strong efficient market or find mispriced investment opportunities. In practice, however, EMH has limitations, as value investors routinely seek to outperform market index funds by analyzing and trading individual mispriced assets.
Each share of a particular stock represents partial ownership of the issuing company. Evaluating stocks is often challenging because there are numerous market factors to consider. Since there is no single universal approach, stock valuation may vary depending on which method is used and how information is interpreted among investors. To value stocks, investors must consider the business fundamentals of the issuing company to calculate current earnings and also project future growth. Moreover, investors may be psychologically conditioned by news media.Reports of company layoffs, store closings and other market announcements play an estimated role in stock price valuation .
Bonds function similar to interest-bearing loans. Both government and private institutions issue bonds to raise capital, and bondholders receive regular interest payments plus the principal value of the bond at maturity. In general, bonds pay lower yields and are less volatile than stocks. Bond valuation is fairly straightforward, as bonds pay fixed coupon rates and have specific maturity dates. However, bond valuation also takes into consideration other variable factors, such as market interest rates and the creditworthiness of the issuing company or government.
Market Efficiency: Stocks vs. Bonds
Overall, developments in information technology and disclosure requirements have influenced market efficiency by making it easier and less costly to retrieve information. Modern investors can quickly locate and analyze a wide array of information using the Internet, although the value and utility of the information may vary depending on the source. Because bondholders are promised a fixed return, bond valuation is generally easier and more precise than stock valuation, as shares do not mature and stock returns are more closely tied to varying company performance. Bond valuation, however, is influenced by a small number of private credit rating agencies that subjectively grade the creditworthiness of bond issuers. Unlike stocks, bonds are not traded in centralized exchange or trading systems. Concerns about the liquidity of certain bond markets and issues of transparency surfaced in the wake of the 2008 global economic crisis.
- Forbes: Efficient Market Hypothesis: Is the Stock Market Efficient?
- How the Market Works: Stock Price Factors
- Morningstar: Efficient Market Hypothesis
- Diffen: Bond vs. Stock
- M&G Investments: Corporate Bond Market Liquidity -- Flush or Flushed?
- Council on Foreign Relations: The Credit Rating Controversy
- The Federal Reserve Board: Technology, Information Production, and Market Efficiency
- Dow Publishing Company: "Growth" vs. "Value" Investing
- The Wall Street Journal: Evaluating a Stock
- The Wall Street Journal: What Is a Bond?