Efficient Market Hypothesis

Capital markets provide a function which facilitates the buying and selling of long-term financial securities to increase liquidity and their value, Watson & Head (2013). Hence, the Efficient Market Hypothesis (EMH) explains the relationship that exists with the prices of the capital market securities, where no individual can beat the market by regularly buying securities at a lower price than it should be. This means that in order to be an efficient market prices of securities will have to fairly and fully reflect all available information, Fama (1970). Consequently, Watson & Head (2013) believe that market efficiency refers to the speed and quality of how share price adjusts to new information. Nevertheless, the testing of the efficient markets has led to the recognition of three different forms of efficiency in which explains how information available is used within the market. In this essay, the EMH will be analysed; testing of EMH will show that the model does provide strong evidence to explain share behaviour but also anomalies will be discussed that refutes the EMH. Therefore, a judgment will be made to see which structure explains the efficient market and whether there are some implications with the EMH, as a whole.

It is believed that Efficient Market Theory is based upon some fallacies and it does not provide strong grounds of whatever that it proposes. More importantly the Efficient Market theory is perceived to be too subjective in its definition and details and because of this it is close to impossible to accommodate this theory into a meaningful and explicit financial model that can actually assist investors in making the investment decisions (Andresso-O’Callaghan, B., 2007).

As Chapter 10 questions, if further evidence continues to surface that capital markets do not always behave in accordance with the efficient market hypothesis, then should we reject the research that has embraced the EMH as a fundamental assumption? In this regard we can return to earlier chapters of this book in which we emphasised that theories are abstractions of reality. Capital markets are made of individuals and as such it would not (or perhaps, should not) be surprising to find that the

In this literate review the most important papers about explaining stock returns from 1952, when Markowitz came up with Modern Portfolio Theory, till around 2011 will be discussed. As stated in Chapter 2, Jack Treynor was one of the first economists that started to work on the CAPM model. When he developed the CAPM in 1961, there was no way yet to fully test it. Because there were no samples large enough or of sufficient quality, the real testing of the CAPM started in 1970. In 1973, the world was shown the famous Black and Scholes options pricing model. One of the first studies that gave a different answer than the CAPM was the research by Basu (1977). While he agrees with the Efficient Market Hypothesis, Basu reaches another

What is the efficient-markets hypothesis? What does it imply about the role of portfolio managers?

It was previously assumed that economic investors and regulators (agents) utilised all available information and thus market prices were a reflection of this information with assets representing their fundamental value, encouraging the position that agents’ actions were rational. The 2007-2008 Global Financial Crisis (GFC) is posited to have originated from the notion that all available information was utilised, causing agents to fail to thoroughly investigate and confirm “the true values of publicly traded securities,” leading to a failure to register the presence of an asset price bubble preceding the GFC (Ball 2009).

The efficient markets theory, according to NASDAQ (n.d.) is the, “Principle that all assets are correctly priced by the market, and that there are no bargains,” (para. 1). This theory implies that supply and demand dictate the reasonable market value for products. Without high demand, the supply will be greater and prices will be lower. Respectively, as demand increases so do the prices until the supply and demand are at equilibrium.

The premise of an efficient market is that stock prices adjust accordingly as information is received. The speed and accuracy of the pricing changes are a reflection of the strength of the market efficiency, where in theory a perfectly efficient market will re-adjust prices immediately and precisely with new information. The efficient market hypothesis aligns with beliefs about whether technical and fundamental analyses are useful in making investment decisions or whether a passive approach is appropriate. In a perfectly efficient market, these types of analyses are not able to predict stock price trends (based on market inefficiencies or price abnormalities) which could assist in portfolio positioning or investment management. However, some investors belive that the market pricing is not precise and that there are timing windows and pricing trends that can be identified through analysis of past performance and finding price abnormalities where all information is not correctly reflected in the stock price (Hirt, Block and Basu, 2006).

The efficient-market hypothesis (EMH) is one of the well-known methods for measuring the future value of stock prices. According to this hypothesis, the market is efficient if its prices are formed on the basis of all disposable information. According to EMH if there is a possibility to predict the future price of shares, that is the first sign of an inefficient market.

It can fairly be said that an Investor considering an investment decision (whether to purchase, sell or hold stock) in publicly traded company acts on the basis of extensive information which is available by corporation to him until the last moment of his investing decision and try to determine the fair price of corporate stock. In the light of continuous creation of a particular impression of corporate affairs by the corporation, new information by corporate can vanish the importance of previous available information to investor. In the scenario only one kind of investors can get advantage over others, who is either very close to corporate operation (corporate officers) or can access nonpublic price-sensitive information to corporation

Efficient Market Hypothesis has been controversial issues among researcher for decades. Until now, there is no united conclusion whether capital markets are efficiency or not. In 1960s, Fama (1970) believed that market is very efficient despite there are some trivial contradicted tests. Until recently, both empirical and theatrical efficient market hypothesis was being disputed by behavior finance economist. They have found that investor have psychological biases and found evidences that some stocks outperform other stocks. Moreover, there are evidences prove that market are not efficient for instance financial crisis, stock market bubble, and some investor can earn abnormal return which happening regularly in stock markets all over the world. Therefore, the purpose of this essay is to demonstrate that Efficient Market Hypothesis in stock (capital) markets does not exist in the real world by proofing four outstanding unrealistic conditions that make market efficient: information is widely available and cost-free, investor are rational, independent and unbiased, There is no liquidity problem in stock market, and finally stock prices has no pattern.

Last but not least important, an efficient capital market is one in which stock prices fully reflect all available information. However, the paradox is that since information is reflected in security prices quickly, knowing information when it is released does an investor little good. Furthermore, it is impossible to create a portfolio which would earn extraordinary risk adjusted return. As a consequence, all the technical and fundamental analysis are useless, no one can consistently outperform the market, and new

Semi-strong form EMH is reflecting all publicy available information. It assumes stock adjust quickly to absorb new information. It also incorporate weak-form EMH. Stock prices reflect all new available information. And those investors will purchase stock after new information released. But the investor cannot benefit over market by trading on new information. And it is risk-adjusted return. Semi-strong form is mostly supported by empirical evidence. Notion of semi-strong efficiency are strongly supported by the evidence, but occasional studies as those identifying market anomalies including the small-firm effect and the January effect and events like stock market crash of October 19, 1987 are inconsistent with this form of market efficiency. Black suggests that most so-called "anomalies" result from data

According the definition of EMH, the price which shown on the stock market already were the best results that shows the company’s operating ability. Therefore, it does not matter how much effort made by the stock firm and investor, and how cautious they are. Information already reacted in the stock prices, whether it is an expensive stock or a cheaper one. It seems that how much information could be reflected in price might the distinction of different form of market efficiency. Roberts (1967) had clearly defined the difference between the weak form, semi-strong form, and strong, and it further summarised by Fama (1970) to define the information efficiency, which is: “A market in which prices always ‘fully reflect’ available information is called ‘efficient’”. In the fact that several form market efficiency act in EMH indicates that does those forms real acts in the capital market should be analysed and proved.

“Investing in a market where people believe in efficiency is like playing bridge with someone who has been told it doesn’t do any good to look at the cards”.