What are the weaknesses of capital market research?

Question

What will be an ideal response?

Answer 1

ANSWER:
Determining cause and effect between information and security prices is difficult because new information is continuously causing price movements. Since the set of information affecting security prices is large, it is extremely difficult to isolate the effects of one piece of information. In addition, only a relatively small group of investors, those at the margin who influence stock prices, are examined. The methodology is not always capable of detecting information content, so stronger evidence from efficient markets research exists where there is information content rather than where there is none.

Another weakness of capital market research is that it is a joint test of both market efficiency and information content. The absence of price responses is usually interpreted to mean the information tested has no information content; however, this interpretation is correct only if the market is efficient. If the market is inefficient, there is no way of determining what the absence of a price response means.

Finally, market-based research necessarily considers only the aggregate effect of individual investor decision making. The role of accounting information is modeled as a black box: an event, the reporting of accounting information, occurs, and the effect of this event is then inferred from whether there was a market reaction.