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What Are the Different Types of Capital Market Theory?

Osmand Vitez
Osmand Vitez

Capital markets generally define the environment in which individuals and businesses trade securities, buy and sell bonds, and make other large-scale financial arrangements. With this economic base, different types of capital market theory exist on how an economy should attempt to govern these markets. In classical economics, capital market theory often defines three major types: weak, semistrong, and strong. Each of these theories attempts to define the market efficiency in capital markets and how individuals and businesses can best leverage information for their best use. For example, a weak form market cannot predict future financial values, and semistrong market prices reflect public information gathered in the market, while string markets use both public and private information to create an efficient market.

In a modern economy in the information age, efficient markets usually require many types of data in order to create the best economic environment. A weak-form capital market theory generally suggests that a given market lacks the information or data necessary for individuals to predict future financial returns. For example, not having data on previous trades or other economic fundamentals in the market restricts how an individual may act currently and in the future. Having no record on the financial returns for a given bond issued by a certain company may indicate investors are unwilling to accept the associated risk for this investment. Information on trading stocks and other investments may also not be present, creating the weak-form market environment.

Businessman giving a thumbs-up
Businessman giving a thumbs-up

The semistrong capital market theory is typically the next stage among the most common capital market reviews. In this market, public information is available on certain investments or other transactions in the capital market. Public information may include items such as public accounting data, information on current competition in the market, and industry knowledge specific to a group of companies. The biggest difference between a weak-form capital market and semistrong market is the ability to view public information at little or no cost. Obtaining in-depth public information in a semistrong market, however, separates the two markets in a very distinct matter.

A strong capital market theory indicates that all public and private information in the capital market is available for use. In most cases, this is not possible as very private information from companies would need to be available in the market. Most companies place limits on the information placed into an open capital market. With this in mind, most capital markets may not be 100 percent efficient or at the strongest point under capital market theory. More information in the market, however, can make it fairly efficient.

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