MARKET EFFICIENCY AND THE BEHAVIOUR OF SECURITIES PRICES Objectives This module is in markets, which can be described as (1) Operational efficiency , and (2) Functional Efficiency or informational and valuation efficiency (1) Operational efficiency The key elements that make a market operationally efficient are market liquidity, orderliness and low costs of trading. Liquidity means investors can dispose of their holdings quickly and without sacrificing large price discounts from prevailing market prices. Factors that contribute to market liquidity are depth, breadth and resilience. Liquidity of the market is indicated by Breadth of market (trading volumes at prevailing prices) Depth of market (volumes of buy orders below and volumes of sell orders above the prevailing price) Market breadth and depth helps to ensure resilience. Market depth means the ability of the market to absorb temporary imbalances between securities supply and demand without leading to large price changes through the trading activities of market makers. Market makers must stand ready to buy up securities when the supply of securities exceed demand, or run down their inventories of securities when demand exceeds supply. Market breadth means trading volume and the existence of adequate competition among market makers to ensure that the spread between ask and bid price is small. Resilience means the ability of the market price to recover from unusually large sell or buy orders. 4 Market orderliness is another important aspect of an operationally efficient market which is closely related to liquidity. In an orderly market price changes are smooth and not erratic. It is again competitive market making activity that ensures orderliness. Absence of price manipulation is important to market orderliness. Price manipulation occurs when some participants have significant market p