What is an efficient market?
Ever since mankind has existed on this planet, the market has existed for anything and everything.
A market is a place where a party that is selling a product or a service and a party that is in need of that product and service come and exchange ‘money’ for the product or service.
Earlier in history buyers practiced ‘barter system’ and slowly the practice changed to paying in gold, silver and other precious metals to the seller in exchange of goods and or services.
The market for any product or service is inefficient in the beginning.
As the market matures i.e., the product or the service becomes widely accepted, monopoly of single seller changes as multiple sellers enter the market leading to price war thus benefitting the buyer, then one can call the mature market as an efficient market. There are many definitions for an efficient market. We at ChilliWealth define the efficient market as the following:
An efficient market is a market in which sellers compete for buyers and offer the best price to the buyer which is in accordance with the willingness to pay (WTP) of the buyer. The Points of Differentiation (PoDs) among the product or services allows the sellers to increase the price to increase profit margin. The Points of Parity (PoPs) increases with time and as new sellers enter the market.
For example, take the smartphone market. When only a few players used to exist such as Nokia, Blackberry, and Motorola, the PoPs were too many that led to commoditization of the cellphones. The PoDs were more about security (Blackberry), tough build and design (Nokia) and radically new designs appealing to the youth (Nokia and Motorola). Enter Apple and Android, the PoDs become more evident. Leading to sunset of Blackberry and Nokia. Now in 2023, the PoDs among Android Phones is limited to size, screen type, camera quality. All Android phones offer the same underlying OS which kills the WTP of the value conscious consumer. Consumer who pay more have a higher WTP for the brand, associated social status with the phone. Social Status is what Apple capitalizes on. The Apple ecosystem is very good but the price the brand demands is entirely in our opinion and analysis based on the cult status and social currency status of the Apple brand.
When it comes to financial markets, the market for traditional financial instruments is fairly mature when compared to newer financial instruments or asset types.
Market for debt instruments, FDs, Pension funds, PPF, Small Savings Schemes, Gold, Commercial Real Estate, and Equity instruments are fairly mature and the sellers can price these with fairly decent knowledge and judgement. Thus these markets are predictable and are efficient.
The newer financial instruments such as crypto currencies are yet to be fully understood and the sellers cannot price them properly. Thus the market for those is inefficient.
Similarly, in developing nations the real estate market lags the transparency offered by mature developed markets such as the USA or UK. In developing nations the real estate market is still inefficient if the buyer is interacting with non-licensed sellers.
So to conclude, an efficient market is a market in which both buyers and sellers compete for a realistic and value oriented price for any product or service. Both buyers and sellers are capable to independently value the product and service and price them accordingly. The value is predictable and the efficiency of the market enables this.
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Till then Adios.
Team ChilliWealth