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Efficient Market Hypothesis: Is the Stock Market Efficient? - Literature review Example

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Efficient Market Hypothesis: Is the Stock Market Efficient?
Introduction
Efficient Market Hypothesis (EMH), introduced four decades ago, was the dominating theory in the academic community that explained how the financial market works. …

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Efficient Market Hypothesis: Is the Stock Market Efficient?

Pesendorfer, 2006; Lim and Tan, 2003; Lo and Mackinlay, 1999), EMH remains one of the major building blocks of modern finance. This theory asserts that the financial markets are "informationally efficient", which means the current prices of assets (i.e., stock, bonds) reflect all the available information. The EMH view of the market is that, when information arises, it spreads very quickly and changes the prices of assets appropriately without delay. Since the information or news is by definition unpredictable, the resulting price changes must be unpredictable. This is called the "random walk" theory (Norstad, 2006). Thus, in the stock market, no investor can select stocks by analysing available stock information and achieve returns greater than those obtained from randomly selected stocks (Hough, 2008).
Despite the wide acceptance of EMH in the academic community for several decades, EMH has not caught the investor's imagination. Almost all professional investors believe they can predict stock prices by analysing information and so beat the market (Christine, 2008). Some of them, including Peter Lynch, Warren Buffet, and Bill Miller, have outperformed the market over long periods. The success of those investors, which is difficult to attribute to pure luck, contradicts EMH. At the same time, EMH has become less universally accepted in the academic community. ...
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