The efficient market theory assumes that there are no transaction costs, money market is not segmented and it is easy to enter the money markets. Efficient market hypothesis is explained in three ways. First, there is weak form efficiency. Weak form efficiency stipulates that all past information that is available in public domain is a reflection of stock prices. The prices are considered unbiased and best estimation of security value. It presumes that it is impossible to predict future prices using past information through technical analysis (Pompian, 2006). Therefore, an investor cannot use technical analysis to predict future prices that are likely to give excess profits (returns). Secondly, there is Semi-strong form efficiency. This form of efficiency stipulates that all publicly available information reflects prices of stock. It further states that prices adjust instantly as new information is made available. Fundamental analysis cannot be relied upon to generate excess returns to the investor. Thirdly, there is strong form efficiency. According to this form of efficiency, prices are reflected by both private (insider) and public information. This means that all investors irrespective of whether they have insider information or not, make equal profits on their investments. It further assumes that insider trading laws are usually enforced. This means that uninformed investors who purchase a diversified portfolio are likely to make same profits as those made by industry experts. Efficient market hypothesis is associated with ‘random walk’. Therefore, if information flow is not hampered and travels immediately in any investment especially stock pricing, the current price reflects current news (Boatright, 2010). Therefore, current prices depend on current news and not yesterday’s news. However, news is usually unpredictable and thus price changes of investments are also likely to be unpredictable and random. According to the efficient market hypothesis, news spread quickly and new information is quickly incorporated into the prices of investment in stocks without delay. This shows that there is no need for technical analysis from past price movements to predict movement of prices. Lee (2009) explained that efficient market hypothesis presumes that large number of profit maximizing investors exists. It also provides that new information must enter the market randomly and independently over time. Efficient market hypothesis has been challenged by economists who believe that there are psychological and behavioral factors that predict returns on investment. According to Malkiel (2003), the new breed of financial economists believes that prices are wholly or partially predictable based on behavioral patterns of individual investors and fundamental valuation metrics. They also argued that predictability of future stock prices enable investors to earn excess profits on their investments. A number of economists, statisticians and other experts have stated that Efficient Market Hypothesis (EMH) is to blame for the global financial crisis that occurred in 2007-2010. This is because of a number of reasons advanced by number of people. First, according to Jeremy Grantham, people had a lot of faith in efficient market hypothesis. This made them to throw caution in the air and underestimate the risk of assets bubbles because they believed that asset market was able to adjust itself accordingly (Nocera, 2009). The investors,
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Efficient market Hypothesis Efficient market hypothesis presumes that market can function exceptionally well in allocating resources. It is a situation where no investor in the money markets can achieve excess profits based on risk-adjustment, if information on the investment is in public domain at the time when making the investment…
The author states that three types of efficient markets are based on certain assumptions and certain hypothesis. The weak-form efficient market hypothesis is based on assumption that current prices of stocks represent the full historical information. The technical analysis would not yield superior risk-related amounts of returns.
Occasionally, due to the availability of certain information, investors will act as if directed in one way or another. The decision to act this way may end up being wrong or right for all investors. “When the price of a stock can be influenced by a “herd” on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person, it is hard to argue that the market always prices rationally.
The paper shows that the studies on Efficient Market Hypothesis undoubtedly make significant contributions on how the society understands the securities market. The reports from researches and studies show that majority of the experts are discontent with the theory. Recent surveys show that criticism for Efficient Market Theory is gaining momentum with time.
Hence, the EMH is of little relevance to corporate managers.’ Explain and discuss this contention. The efficient market hypothesis is a proposition which articulates that the market prices of security are a reflection of available information to the members of public.
Basu illuminates that "in an Efficient Capital Market security prices fully reflect available information in a rapid and unbiased fashion" (1977, p663) This suggests that stock price, at a specific moment, reflects all the information that is available and the events that are announced.
It states that the financial markets are usually efficient in terms of providing the right information to the investors.
It also stipulates that the price of traded assets consists of information that is available for use. The example of traded assets involves; stocks, bonds and the properties.
Indeed, there were several theories and models develop to further increase the understanding on financial markets. The knowledge, however, is subject to various criticisms and judgement. Such process allows the models and theories to be meticulously developed before being accepted.
The response was emanated from the different governments rather than from the market itself as many governments including US and UK governments injected money into the system to safeguard it from complete
Investors will therefore make normal profits. According to this hypothesis, any new information that can influence the prices of securities will spread randomly to all investors. The weak form hypothesis argue that the
is not possible to hit the market due to the reason that the efficiency of stock market causes existing stock prices to incorporate as well as reflect all the pertinent information (Malkiel, 2005). EMH does not entail that the prices of asset are always accurate. It does not
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