Market efficiency twice, hypothesis, efficiency, successful, companies

karoliukas

I am confused about this question. Can someone please clarify?

Analyst develops a model wherein he predicts that companies with P/E ratios twice that of their industry average will generate significant excess return. If analyst consistently makes successful returns using this strategy, which form of market hypothesis has been violated?

Answer is: Semi strong and weak forms only.

My doubt:

Assuming this is a fundamental analysis, as he is predicting his strategy based on fundamental information publicly available. I know using fundamental analysis, abnormal returns can not be earned in the Semi strong efficient market. Since he is earning, he is violating semi strong hypothesis.

On the other hand , I know semi strong market is also weak efficient market. If I follow this reasoning then definitely it is a violation of both.

However, using fundamental analysis, excess return can be earned in weak form of the market so this is not really a violation in case of weak form efficient market hypothesis. Somehow, I have two different reasoning stuck in my head for some reason but don't know why is this? Although I could get this question correct in the mock as none of the options had "Semi strong only". If it had that option I would have probably selected this option, so I would like to get fundamentals right before going for the real exam. Can someone please clarify?

cchang

I dont get how that could be the correct answer..

Since he's able to make money off fundamental analysis, hes likely violated only the Semi-strong form and Strong form and NOT the weak form

My reasoning...

If he realized these returns through:

*Technical Analysis: Weak form, semi strong form and strong form are violated

*Fundamental analysis: Semi-strong and strong form are violated

*Private Information: Only Strong form is violated, the other two have NOT been violated.

trogulj

Think about it another way..

Developed markets are widely believed to be weak form efficient (ie. technical analysis is not useful), but people can still make money off fundamental analysis. So, markets are weak form efficent but semi-strong form inefficient.